Solution Manual for Microeconomics, 9th Edition

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Instructor’s ManualByDuncan M. HolthausenNorth Carolina State UniversityForMicroeconomicsNinth EditionRobert S. PindyckMassachusetts Institute of TechnologyDaniel L. RubinfeldUniversity of California, Berkeley

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ISBN-13: 978-0-13-418486-9ISBN-10: 0-13-418486-6ContentsPART 1:Introduction: Markets and Prices................................................................................1Chapter 1Preliminaries...................................................................................................................2Chapter 2The Basics of Supply and Demand..................................................................................8PART2:Producers, Consumers, and Competitive Markets......................................................28Chapter 3Consumer Behavior.........................................................................................................29Chapter 4Individual and Market Demand.......................................................................................50AppendixDemand Theory—A Mathematical Treatment.................................................................72Chapter 5Uncertainty and Consumer Behavior...............................................................................78Chapter 6Production......................................................................................................................90Chapter 7The Cost of Production...................................................................................................102AppendixProduction and Cost Theory—A Mathematical Treatment...............................................118Chapter 8Profit Maximization and Competitive Supply..................................................................123Chapter 9The Analysis of Competitive Markets..............................................................................141PART 3:Market Structure and Competitive Strategy................................................................163Chapter 10Market Power: Monopoly and Monopsony......................................................................164Chapter 11Pricing with Market Power..............................................................................................190AppendixThe Vertically Integrated Firm........................................................................................215Chapter 12Monopolistic Competition and Oligopoly........................................................................222Chapter 13Game Theory and Competitive Strategy..........................................................................251Chapter 14Markets for Factor Inputs................................................................................................268Chapter 15Investment, Time, and Capital Markets...........................................................................280PART 4:Information, Market Failure, and the Role of Government........................................294Chapter 16General Equilibrium and Economic Efficiency................................................................295Chapter 17Markets with Asymmetric Information............................................................................310Chapter 18Externalities and Public Goods........................................................................................323Chapter 19Behavioral Economics……………………………………………………………………... 342

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PARTONEIntroduction:Marketsand Prices

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Chapter 1PreliminariesTeaching NotesChapter 1 covers basic concepts students first saw in their introductory course but could bear somerepeating.Since most students will not have read this chapter beforethe first class, it is a good time to getthem talking about some of the concepts presented.You might start by asking for a definition of economics.Make sure to emphasize scarcity and trade-offs.Remind students that the objective of economics is toexplain observed phenomena and predict behavior of consumers and firms as economic conditions change.Ask about the differences (and similarities) between microeconomics and macroeconomics and thedifference between positive and normative analysis. Review the concept of a market and the role pricesplay in allocating resources.Discussions of economic theories and models may be a bit abstract at thispoint in the course, but you can lay the groundwork for a deeper discussion that might take place whenyou cover consumer behavior in Chapter 3.Section 1.3 considers real and nominal prices.Given the reliance on dollar prices in the economy, studentsmustunderstand the difference between real and nominal prices and how to compute real prices.Moststudents know about the Consumer Price Index, so you might also mention other price indexes such as theProducer Price Index and the Personal Consumption Expenditures (PCE) Price Index, which is the Fed’spreferred inflation measure.1It is very useful to go over some numerical examples using goods that are inthe news and/or that students often purchase such ascell phones, food, textbooks, and a college education.In general, the first class is a good time to pique student interest in the course.It is also a good time to tellstudents that they need to work hard to learn how to do economic analysis, and that memorization alonewill not get them through the course.Students must learn to think like economists, so encourage them towork lots of problems.Also encourage them to draw graphs neatly and large enough to make them easy tointerpret.It always amazes me to see the tiny, poorly drawn graphs some students produce.It is no wondertheir answers are often incorrect.You might even suggest they bring a small ruler andcolored pencils toclass so they can draw accuratediagrams.Questions for Review1.It is often said that a good theory is one that can be refuted by an empirical, data-orientedstudy.Explain why a theory that cannot be evaluated empirically is not agood theory.A theory is useful only if it succeeds in explaining and predicting the phenomena it was intended toexplain.If a theory cannot be evaluated or tested by comparing its predictions to known facts anddata, then we have no idea whether the theory is valid.If we cannot validate the theory, we cannothave any confidence in its predictions, and it is of little use.1TheCPIandPPIare reported by the Bureau of Labor Statistics (www.bls.gov).The PCE Price Index is compiledby the Bureau of Economic Analysis in the Commerce Department (www.bea.gov).

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Chapter 1Preliminaries332.Which of the following two statements involves positive economic analysis and which normative?How do the two kinds of analysis differ?a.Gasoline rationing (allocating to each individual a maximum amount of gasoline that can bepurchased each year) is poor social policy because it interferes with the workings of thecompetitive market system.Positive economic analysis is concerned with explainingwhat isand predictingwhat will be.Normative economic analysis describeswhat ought to be.Statement (a) is primarily normativebecause it makes the normative assertion (i.e., a value judgment) that gasoline rationing is “poorsocial policy.”There is also a positive element to statement (a), because it claims that gasolinerationing “interferes with the workings of the competitive market system.”This is a predictionthat a constraint placed on demand will change the market equilibrium.b.Gasoline rationing is a policy under which more people are made worse off than are madebetter off.Statement (b) is positive because it predicts how gasoline rationing affects people withoutmaking a value judgment about the desirability of the rationing policy.3.Suppose the price of regular-octane gasoline were 20 cents per gallon higher in New Jersey thanin Oklahoma.Do you think there would be an opportunity for arbitrage (i.e., that firms couldbuy gas in Oklahoma and then sell it at a profit in New Jersey)?Why or why not?Oklahoma and New Jersey represent separate geographic markets for gasoline because of hightransportation costs, so arbitrage is unlikely.There would be an opportunity for arbitrageonlyiftransportation costs were lessthan 20 cents per gallon.Then arbitrageurs could make a profit bypurchasing gasoline in Oklahoma, paying to transport it to New Jersey and selling it in New Jersey.Ifthe transportation costs were20 cents or higher, however, no arbitrage would take place.4.In Example 1.3, what economic forces explain why the real price of eggs has fallen while thereal price of a college education has increased?How have these changes affected consumerchoices?The price and quantity of goodssuch as eggsand services,like a college education,are determinedby the interaction of supply and demand.The real price of eggs fell from 1970 to 2016because ofeither a reduction in demand (e.g., consumers switched to lower-cholesterol food), an increase insupply dueperhaps to a reduction in production costs (e.g., improvements in egg productiontechnology), or both.In response, the price of eggs relative to other foods decreased.The real price ofa college educationrose because of either an increase in demand (e.g., the perceived value of a collegeeducation increased,population increased), a decrease in supply due to an increase in the cost ofproviding an education (increasesin faculty salaries, costs of complying with new regulations,etc.),or both.5.Suppose that the Japanese yen rises against the U.S. dollar—that is, it will take more dollars tobuy a given amount of Japanese yen.Explain why this increase simultaneously increases thereal price of Japanese cars for U.S. consumers and lowers the real price of U.S. automobiles forJapanese consumers.As the value of the yen grows relative to the dollar, it takes more dollars to purchase a yen, and ittakes fewer yen to purchase a dollar.Assume that the costs of production for both Japanese and U.S.automobiles remain unchanged.Then using the new exchange rate, the purchase of a Japaneseautomobile priced in yen requires more dollars, so for U.S. consumers the real price of Japanese cars

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Pindyck/Rubinfeld, Microeconomics,NinthEdition4in dollars increases.Similarly, the purchase of a U.S. automobile priced in dollars requires fewer yen,and thus for Japanese consumers the real price of a U.S.automobile in yen decreases.6.The price of long-distance telephone service fell from 40 cents per minute in 1996 to 22 centsper minute in 1999, a 45%(18 cents/40 cents) decrease.The Consumer Price Index increasedby 10%over this period.What happened to the real price of telephone service?Let theCPIfor 1996 equal 100 and theCPIfor 1999 equal 110, which reflects a 10% increase in theoverall price level.Now let’s find the real price of telephone service (in 1996 dollars) in each year.The real price in 1996 issimply40 cents. To find the real price in 1999, divideCPI1996byCPI1999and multiply the result by the nominal price in 1999.The result is (100/110)2220 cents.The realprice therefore fell from 40 to 20 cents, a 50% decline.Exercises1.Decide whether each of the following statements is true or false and explain why:a.Fast-food chains like McDonald’s, Burger King, and Wendy’s operate all over the UnitedStates.Therefore the market for fast food is a national market.This statement is false.People generally buy fast food locally and do not travel large distancesacross the United States just to buy a cheaper fast-food meal.Because there is little potential forarbitrage between fast-food restaurants that are located some distance from each other, there arelikely to be multiple fast-food markets across the country.b.People generally buy clothing in the city in which they live.Therefore there is a clothingmarket in, say, Atlanta that is distinct from the clothing market in Los Angeles.This statement ismostlyfalse.Although consumers are unlikely to travel across the country tobuy clothing, they can purchase many items online.In this way, clothing retailers in differentcities compete with each other and with online stores such asAmazon,L.L. BeanandZappos.com.Also, suppliers can easily move clothing from one part of the country to another.Thus, if clothing is more expensive in Atlanta than Los Angeles, clothing companies can shiftsupplies to Atlanta, which would reduce the price in Atlanta.Occasionally, there may be amarket for a specific clothing item in a faraway market that results in a great opportunity forarbitrage, such as the market for blue jeans in the old Soviet Union.c.Some consumers strongly prefer Pepsi and some strongly prefer Coke.Therefore there isno single market for colas.This statement is false.Although some people have strong preferences for a particular brand ofcola, the different brands are similar enough that they constitute one market. There are consumerswho do not have strong preferences for one type of cola, and there are consumers who may havea preference, but who will also be influenced by price.Given these possibilities, the price of coladrinks will not tend to differ by very much, particularly for Coke and Pepsi.2.The following table shows the average retail price of butter and the Consumer Price Index from1980 to 2010, scaled so that theCPI100 in 1980.

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Chapter 1Preliminaries551980199020002010CPI100158.56208.98218.06Retail price of butter(salted, grade AA, per lb.)$1.88$1.99$2.52$2.88

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Pindyck/Rubinfeld, Microeconomics,NinthEdition6a.Calculate the real price of butter in 1980 dollars.Has the real price increased/decreased/stayed the same from 1980 to 2000?From 1980 to 2010?Real price of butter in yeart1980tCPICPInominal price of butter in yeart.1980199020002010Real price of butter (1980 $)$1.88$1.26$1.21$1.32The real price of butter decreasedfrom $1.88 in1980 to $1.21 in 2000, and it decreased from$1.88 in 1980 to $1.32 in 2010, although it did increase between 2000 and 2010.b.What is the percentage change in the real price (1980 dollars) from 1980 to 2000?From1980 to 2010?Real price decreased by $0.67 (1.881.210.67) between 1980 and 2000.The percentagechange in real price from 1980 to 2000 was therefore (0.67/1.88)100%35.6%.Thedecrease was $0.56 between 1980 and 2010 which, in percentage terms, is (0.56/1.88)100%29.8%.c.Convert theCPIinto 1990100 and determine the real price of butter in 1990 dollars.To convert theCPIso that1990100, divide theCPIfor each year by theCPIfor 1990 andmultiply that result by 100.Use the formula fromanswer (a)and the newCPInumbers below tofind the real price of butterin 1990 dollars.1980199020002010NewCPI63.07100131.80137.53Real price of butter (1990 $)$2.98$1.99$1.91$2.09d.What is the percentage change in the real price (1990 dollars) from 1980 to 2000?Comparethis with your answer in (b).What do you notice?Explain.Real price decreased by $1.07 (2.981.911.07).The percentage change in real price from1980 to 2000 was therefore (1.07/2.98)100%35.9%.This answer is the same (except forrounding error) as in (b).It does not matter which year is chosen as the base year whencalculatingpercentagechanges in real prices.3.At the time this book went to print, the minimum wage was $7.25.To find the current value oftheCPI, go tohttp://www.bls.gov/cpi/home.htm.Click on “CPITables,” which is foundon theleft side of the website.Then, click on “Table Containing History ofCPI-U U.S.All ItemsIndexes and Annual Percent Changes from 1913 to Present.”This will give you theCPIfrom1913 to the present.a.With these values, calculate the current real minimum wage in 1990 dollars.The lastCPI valueavailable when these answers were prepared wasOctober 2016.Thus,allcalculations are as of that date. You should update the CPI valueforyour answers.Real minimum wage inOctober201620161990CPICPIminimum wage729.2417.130$7.25$3.92.So, as of October 2016, the real minimum wage in 1990 dollars was $3.92.

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Chapter 1Preliminaries77b.Stated in real 1990 dollars, what is the percentage change in the real minimum wage from1985 to the present?The minimum wage in 1985 was $3.35.You can get a complete listing of historical minimumwage rates from the Department of Labor, Wage and Hour Division at http://www.dol.gov/whd/minwage/chart.htm.Real minimum wage in 198519901985CPICPI$3.35130.7107.6$3.35$4.07in 1990 dollars.The real minimumwage(in 1990 dollars)therefore decreased slightly from $4.07 in 1985 to$3.92 in 2016.This is a decrease of $4.073.92$0.15, so the percentage changeis (0.15/4.07)100%3.69%.

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Chapter2The Basics of Supply and DemandTeaching NotesThis chapter reviews the basics of supply and demand that students should be familiar with from theirintroductory economics courses.You may choose to spend more or less time on this chapter dependingon how much review your students require.Chapter 2 departs from the standard treatment of supply anddemand basics found in most other intermediate microeconomics textbooks by discussing many real-worldmarkets (copper, office space in New York City, wheat, gasoline, natural gas, coffee,and others) andteaching students how to analyze these markets with the tools of supply and demand.The real-worldapplications are intended to show students the relevance of supply and demand analysis, and you mayfind it helpful to refer to these examples during class.One of the most common problems students have in supply/demand analysis is confusion between amovement along a supply or demand curveand ashift in the curve.You should stress theceteris paribusassumption, and explain that all variables except price are held constant along a supply or demand curve.So movements along the demand curve occuronly with changes in price.When one of the omitted factorschanges, the entire supply or demand curve shifts.You might find it useful to make up a simple lineardemand function with quantity demanded on the left and the good’s price, a competing good’s price andincome on the right.This gives you a chance to discuss substitutes and complements and also normal andinferior goods.Plug in values for the competing good’s price and income and plot the demand curve.Thenchange, say, the other good’s price and plot the demand curve again to show that it shifts.This demonstrationhelps students understand that the other variables are actually in the demand function and are merelylumped into the intercept term when we draw a demand curve.The same, of course, applies to supplycurves as well.It is important to make the distinction between quantity demanded as a function of price,QDD(P),andthe inverse demand function,PD1(QD),where price is a function of the quantity demanded.Since weplot price on the vertical axis, the inverse demand function is very useful.You can demonstrate this if youuse an example as suggested above and plot the resulting demand curves.And, of course, there are“regular” and inverse supply curves as well.Students also can have difficulties understanding how a market adjusts to a new equilibrium.They oftenthink that the supply and/or demand curves shift as part of the equilibrium process.For example, supposedemand increases.Students typically recognize that price must increase, but some go on to say that supplywill also have to increase to satisfy the increased level of demand.This may be a case of confusing anincrease in quantity supplied with an increase in supply, but I have seen many students draw a shift insupply, so I try to get this cleared up as soon as possible.The concept of elasticity, introduced in Section 2.4, is another source of problems.It is important to stressthe fact that any elasticity is the ratio of two percentages.So, for example, if a firm’s product has a priceelasticity of demand of2, the firm can determine that a 5% increase in price will result in a 10% drop insales.Use lots of concrete examples to convince students that firms and governments can make important

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Chapter2The Basics of Supply and Demand9use of elasticity information.A common source of confusion is the negative value for the price elasticityof demand.We often talk about it as if it were a positive number. The book is careful in referring to the“magnitude” of the price elasticity, by which it means the absolute value of the price elasticity, but studentsmay not pick this up on their own.I warn students that I will speak of price elasticities as if they werepositive numbers and will say that a good whose elasticity is2 is more elastic (or greater) than one whoseelasticity is1, even though the mathematically inclined may cringe.Section 2.6 brings a lot of this material together because elasticities are used to derive demand and supplycurves, market equilibria arecomputed, curves are shifted, and new equilibria are determined.This showsstudents how we can estimate the quantitative (not just the qualitative) effects of, say, a disruption in oilsupply as in Example 2.9.Unfortunately, this section takes some time to cover, especially if your students’algebra is rusty.You’ll have to decide whether the benefits outweigh the costs.Price controls are introduced in Section 2.7.Students usually don’t realize the full effects of price controls.They think only of the initial effect on prices without realizing that shortages or surpluses are created, sothis is an important topic.However, the coverage here is quite brief.Chapter 9 examines the effects ofprice controls and other forms of government intervention in much greater detail, so you may want todefer this topic until then.Questions for Review1.Suppose that unusually hot weather causes the demand curve for ice cream to shift to the right.Why will the price of ice cream rise to a new market-clearing level?Suppose the supply of ice cream is completely inelastic in the short run, so the supply curve isvertical as shown below.The initial equilibrium is at priceP1.The unusually hot weather causes thedemand curve for ice cream to shift fromD1toD2, creating short-run excess demand (i.e., a temporaryshortage) at the current price.Consumers will bid against each other for the ice cream, puttingupward pressure on the price, and ice cream sellers will react by raising price.The price of ice creamwill rise until the quantity demanded and the quantity supplied are equal, which occurs at priceP2.

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10Pindyck/Rubinfeld, Microeconomics,NinthEdition2.Use supply and demand curves to illustrate how each of the following events would affect theprice of butter and the quantity of butter bought and sold:a.An increase in the price of margarine.Butter and margarine are substitute goods for most people.Therefore, an increase in the price ofmargarine will cause people to increase their consumption of butter, thereby shifting the demandcurve for butter out fromD1toD2in Figure 2.2.a.This shift in demand causes the equilibriumprice of butter to rise fromP1toP2and the equilibrium quantity to increase fromQ1toQ2.Figure 2.2.ab.An increase in the price of milk.Milk is the main ingredient in butter.An increase in the price of milk increases the cost ofproducing butter, which reduces the supply of butter.The supply curve for butter shifts fromS1toS2in Figure 2.2.b, resulting in a higher equilibrium price,P2and a lower equilibriumquantity,Q2, for butter.Figure 2.2.b

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Chapter2The Basics of Supply and Demand11Note:Butter is in fact made from the fat that is skimmed from milk; thus butter and milk are jointproducts, and this complicates things.If you take account of this relationship, your answer mightchange, but it depends on why the price of milk increased.If the increase were caused by anincrease in the demand for milk, the equilibrium quantity of milk supplied would increase.Withmore milk being produced, there would be more milk fat available to make butter, and the priceof milk fat would fall.This would shift the supply curve for butter to the right, resulting in a dropin the price of butter and an increase in the quantity of butter supplied.c.A decrease in average income levels.Assuming that butter is a normal good, a decrease in average income will cause the demandcurve for butter to decrease (i.e., shift fromD1toD2).This will result in a decline in theequilibrium price fromP1toP2, and a decline in the equilibrium quantity fromQ1toQ2.SeeFigure 2.2.c.Figure 2.2.c3.If a 3%increase in the price of corn flakes causes a 6%decline in the quantity demanded, whatis the elasticity of demand?The elasticity of demand is the percentage change in the quantity demanded divided by thepercentage change in the price.The elasticity of demand for corn flakes is therefore%62.%3DPQEP 4.Explain the difference between a shift in the supply curve and a movement along the supplycurve.A movement along the supply curve occurs when the price of the good changes.A shift of the supplycurve is caused by a change in something other than the good’s price that results in a change in thequantity supplied at the current price.Some examples are a change in the price of an input, a changein technology that reduces the cost of production,and an increase in the number of firms supplyingthe product.

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12Pindyck/Rubinfeld, Microeconomics,NinthEdition5.Explain why for many goods, the long-run price elasticity of supply is larger than the short-runelasticity.The price elasticity of supply is the percentage change in the quantity supplied divided by thepercentage change in price.In the short run, an increase in price induces firms to produce more byusing their facilities more hours per week, paying workers to work overtime and hiring new workers.Nevertheless, there is a limit to how much firms can produce because they face capacity constraintsin the short run.In the long run, however, firms can expand capacity by building new plants andhiring new permanent workers.Also, new firms can enter the market and add their output to totalsupply.Hence a greater change in quantity supplied is possible in the long run, and thus the priceelasticity of supply is larger in the long run than in the short run.6.Why do long-run elasticities of demand differ from short-run elasticities? Consider two goods:paper towels and televisions.Which is a durable good?Would you expect the price elasticity ofdemand for paper towels to be larger in the short run or in the long run?Why? What about theprice elasticity of demand for televisions?Long-run and short-run elasticities differ based on how rapidly consumers respond to price changesand how many substitutes are available.If the price of paper towels, a nondurable good, were toincrease, consumers might react only minimally in the short run because it takes time for people tochange their consumption habits.In the long run, however, consumers might learn to use otherproducts such as sponges or kitchen towels instead of paper towels.Thus, the price elasticity wouldbe larger in the long run than in the short run.In contrast, the quantity demanded of durable goods,such as televisions, might change dramatically in the short run.For example, the initial result of aprice increase for televisions would cause consumers to delay purchases because they could keepon using their current TVs longer.Eventually consumers would replace their televisions as they woreout or became obsolete. Therefore, we expect the demand for durables to be more elastic in the shortrun than in the long run.7.Are the following statements true or false?Explain your answers.a.The elasticity of demand is the same as the slope of the demand curve.False.Elasticity of demand is the percentage change in quantity demanded divided by thepercentage change in the price of the product.In contrast, the slope of the demand curve isthechange in quantity demanded (in units) divided by the change in price (typically in dollars).The difference is that elasticity uses percentage changes while the slope is based on changesin the number of units and number of dollars.b.The cross-price elasticity will always be positive.False.The cross-price elasticity measures the percentage change in the quantity demanded ofone good due to a1%change in the price of another good. This elasticity will be positive forsubstitutes (an increase in the price of hot dogs is likely to cause an increase in the quantitydemanded of hamburgers) and negative for complements (an increase in the price of hot dogs islikely to cause a decrease in the quantity demanded of hot dog buns).c.The supply of apartments is more inelastic in the short run than the long run.True.In the short run it is difficult to change the supply of apartments in response to a change inprice.Increasing the supply requires constructing new apartment buildings, which can take a yearor more.Therefore, the elasticity of supply is more inelastic in the short run than in the long run.

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Chapter2The Basics of Supply and Demand138.Suppose the government regulates the prices of beef and chicken and sets them below theirmarket-clearing levels.Explain why shortages of these goods will develop and what factors willdetermine the sizes of the shortages.What will happen to the price of pork?Explain briefly.If the price of a commodity is set below its market-clearing level, the quantity that firms are willingtosupply is less than the quantity that consumers wish to purchase.The extent of the resulting shortagedepends on the elasticities of demand and supply as well as the amount by which the regulated priceis set below the market-clearing price. For instance, if both supply and demand are elastic, the shortageis larger than if both are inelastic, and if the regulated price is substantially below the market-clearingprice, the shortage is larger than if the regulated price is only slightly below the market-clearing price.Factors such as the willingness of consumers to eat less meat and the ability of farmers to reduce thesize of their herds/flocks will determine the relevant elasticities.Customers whose demands forbeef and chicken are not met because of the shortages will want to purchase substitutes like pork.This increases the demand for pork (i.e., shifts demand to the right), which results in a higher pricefor pork.9.The city council of a small college town decides to regulate rents in order to reduce studentliving expenses.Suppose the average annual market-clearing rent for a two-bedroom apartmenthad been $700 per month and that rents were expected to increase to $900 within a year.Thecity council limits rents to their current $700-per-month level.a.Draw a supply and demand graph to illustrate what will happen to the rental price of anapartment after the imposition of rent controls.Initially demand isD1and supply isS, so the equilibrium rent is $700 andQ1apartments arerented.Without regulation, demand was expected to increase toD2, which would have raisedrent to $900 and resulted inQ2apartment rentals.Under the city council regulation, however,the rental price stays at the old equilibrium level of $700 per month.After demand increases toD2, onlyQ1apartments will be supplied whileQ3will be demanded.There will be a shortage ofQ3Q1apartments.a.Do you think this policy will benefit all students?Why or why not?No.It will benefit those students who get an apartment,although these students may find that thecost of searching for an apartment is higher given the shortage of apartments.Those students whodo not get an apartment may face higher costs as a result of having to live outside the collegetown.Their rent may be higher and their transportation costs will be higher, so they will be worseoff as a result of the policy.

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14Pindyck/Rubinfeld, Microeconomics,NinthEdition10.In a discussion of tuition rates, a university official argues that the demand for admission iscompletely price inelastic.As evidence, she notes that while the university has doubled itstuition (in real terms) over the past 15 years, neither the number nor quality of studentsapplying has decreased.Would you accept this argument?Explain briefly.(Hint: The officialmakes an assertion about the demand for admission, but does she actually observe a demandcurve?What else could be going on?)I would not accept this argument.The university official assumes that demand has remained stable(i.e., the demand curve has not shifted) over the 15-year period.This seems very unlikely.Demandfor college educations has increased over the years for many reasons—real incomes have increased,population has increased, the perceived value of a college degree has increased, etc.What hasprobably happened is that tuition doubled fromT1toT2, but demand also increased fromD1toD2over the 15 years, and the two effects have offset each other.The result is that the quantity (andquality) of applications has remained steady atA.The demand curve is not perfectly inelastic asthe official asserts.11.Suppose the demand curve for a product is given byQ102PPS, wherePis the price ofthe product andPSis the price of a substitute good.The price of the substitute good is $2.00.a.SupposeP$1.00.What is the price elasticity of demand?What is the cross-price elasticityof demand?Find quantity demanded whenP$1.00 andPS$2.00.Q102(1)210.Price elasticity of demand12( 2)0.2.1010PQQP  Cross-price elasticity of demand2 (1)0.2.10ssPQQPb.Suppose the price of the good,P, goes to $2.00.Now what is theprice elasticity of demand?What is the cross-price elasticity of demand?WhenP$2.00,Q102(2)28.Price elasticity ofdemand24( 2)0.5.88PQQP  Cross-price elasticity of demand2 (1)0.25.8ssPQQP

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Chapter2The Basics of Supply and Demand1512.Suppose that rather than the declining demand assumed in Example 2.8, a decrease in the costof copper production causes the supply curve to shift to the right by 40%.How will the price ofcopper change?If the supply curve shifts to the right by 40% then the new quantity supplied will be 140%of the oldquantity supplied at every price.The new supply curve is therefore the old supply curve multipliedby 1.4.QS1.4 (99P)12.612.6P.To find the new equilibrium price of copper, set the new supplyequal to demand.Thus,–12.612.6P273P.Solving for price results inP$2.54 per pound forthe new equilibrium price.The price decreased by 46cents per pound, from $3.00 to $2.54, a drop ofabout 15.3%.13.Suppose the demand for natural gas is perfectly inelastic.What would be the effect, if any, ofnatural gas price controls?If the demand for natural gas is perfectly inelastic, the demand curve is vertical.Consumers willdemand the same quantity regardless of price.In this case, price controls will have no effect on thequantity demanded, but they will still cause a shortage if the supply curve is upward sloping and theregulated price is set below the market-clearing price, because suppliers will produce less natural gasthan consumers wish to purchase.Exercises1.Suppose the demand curve for a product is given byQ3002P4I, whereIis averageincome measured in thousands of dollars.The supply curve isQ3P50.a.IfI25, find the market-clearing price and quantity for the product.GivenI25, the demand curve becomesQ300−2P4(25), orQ400−2P.Set demandequal to supply and solve forPand thenQ:4002P3P50P90Q4002(90)220.b.IfI50, find the market-clearing price and quantity for the product.GivenI50, the demand curve becomesQ3002P4(50), orQ5002P.Setting demandequal to supply, solve forPand thenQ:5002P3P50P110Q5002(110)280.c.Draw a graph to illustrate your answers.It is easier to draw the demand and supply curves if you first solve for the inverse demand andsupply functions, i.e., solve the functions forP.Demand in part aisP2000.5Qand supplyisP16.670.333Q.These are shown on the graph asDaandS.Equilibrium price and quantityare found at the intersection of these demand and supply curves.When the income level increases

Solution Manual for Microeconomics, 9th Edition - Page 19 preview image

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16Pindyck/Rubinfeld, Microeconomics,NinthEditionin part b, the demand curve shifts up and to the right.Inverse demand isP2500.5Qand islabeledDb. The intersection of the new demand curve and original supply curve is the newequilibrium point.2.Consider a competitive market for which the quantities demanded and supplied (per year) atvarious prices are given as follows:Price (Dollars)Demand (Millions)Supply (Millions)60221480201610018181201620a.Calculate the price elasticity of demand when the price is $80 and when the price is $100..DDDDDQQQPEPQPPWith each price increase of $20, the quantity demanded decreases by 2 million.Therefore,20.1.20DQP  AtP80, quantity demanded is 20 million and thus80( 0.1)0.40.20DE Similarly, atP100, quantity demanded equals 18 million and100( 0.1)0.56.18DE 

Solution Manual for Microeconomics, 9th Edition - Page 20 preview image

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Chapter2The Basics of Supply and Demand17b.Calculate the price elasticity of supply when the price is $80and when the price is $100..SSSSSQQQPEPQPPWith each price increase of $20, quantity supplied increases by 2 million.Therefore,20.1.20SQP AtP80, quantity supplied is 16 million and80(0.1)0.5.16SESimilarly,atP100, quantity supplied equals 18 million and100(0.1)0.56.18SEc.What are the equilibrium price and quantity?The equilibrium price is the price at which the quantity supplied equals the quantity demanded.Using the table, the equilibriumprice isP*$100 and the equilibrium quantity isQ*18 million.d.Suppose the government sets a price ceiling of $80.Will there be a shortage, and if so, howlarge will it be?With a price ceiling of $80, price cannot be above $80, so the market cannot reach its equilibriumprice of $100.At $80, consumers would like to buy 20 million, but producers will supply only16 million.This will result in a shortage of 4 million units.3.Refer to Example 2.5 (page 37) on the market for wheat.In 1998, the total demand for U.S.wheat wasQ3244283P and the domestic supply wasQS1944207P.At the end of 1998,both Brazil and Indonesia opened their wheat markets to U.S. farmers.Suppose that these newmarkets add 200 million bushels to U.S. wheat demand.What will be the free-marketprice ofwheat and what quantity will be produced and sold by U.S. farmers?If Brazil and Indonesia add 200 million bushels of wheat to U.S. wheat demand, the new demandcurve will beQ200, orQD(3244283P)2003444283P.Equate supply and the new demand to find the new equilibrium price.1944207P3444283P, or490P1500, and thusP$3.06 per bushel.To find the equilibrium quantity, substitute the price into either the supply or demand equation.Using demand,QD3444283(3.06)2578 million bushels.

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18Pindyck/Rubinfeld, Microeconomics,NinthEdition4.A vegetable fiber is traded in a competitive world market, and the world price is $9 per pound.Unlimited quantities are available for import into the United States at this price.The U.S.domestic supply and demand for variousprice levels are shown as follows:PriceU.S. Supply(Million LBS)U.S. Demand(Million LBS)3234642896221281615101018124a.What is the equation for demand?What is the equation for supply?The equation for demand is of the formQabP.First find the slope, which is62.3QbP  You can figure this out by noticing that every time price increases by 3,quantity demanded falls by 6 million pounds.Demand is nowQa2P.To finda, plug in anyof the price and quantitydemanded points from the table. For example:Q34a2(3) so thata40 and demand is thereforeQ402P.The equationforsupply is of the formQcdP.First find the slope, which is2.3QdPYou can figure this outby noticing that every time price increases by 3, quantity suppliedincreases by 2 million pounds.Supply is now2.3QcPTo findc, plug in any of the priceand quantity supplied points from the table.For example:22(3)3Qcso thatc0 andsupply is2.3QPb.At a price of $9, what is the price elasticity of demand?What is it at a price of $12?Elasticity of demand atP9 is918( 2)0.82.2222PQQP Elasticity of demand atP12 is1224( 2)1.5.1616PQQP c.What is the price elasticity of supply at $9?At $12?Elasticity of supply atP9 is92181.0.6318PQQPElasticity of supply atP12 is122241.0.8324PQQP

Solution Manual for Microeconomics, 9th Edition - Page 22 preview image

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Chapter2The Basics of Supply and Demand19d.In a free market, what will be the U.S. price and level of fiber imports?With no restrictions on trade, the price in the United States will be the same as the world price,soP$9.At this price, the domestic supply is 6 million lbs., while the domestic demand is22 million lbs.Imports make up the difference and arethus 226 =16 million lbs.5.Much of the demand for U.S. agricultural output has come from other countries.In 1998, thetotal demand for wheat wasQ3244283P.Of this, total domestic demand wasQD1700107P, and domestic supply wasQS1944207P.Suppose the export demand for wheat fallsby 40%.a.U.S. farmers are concerned about this drop in export demand.What happens to the free-market price of wheat in the United States?Do farmers have much reason to worry?Before the drop in export demand, the market equilibrium price is found by setting total demandequal to domestic supply:3244283P1944207P, orP$2.65.Export demand is the difference between total demand and domestic demand:Q3244283PminusQD1700107P.So export demand is originallyQe1544176P.After the 40%drop,export demand is only 60%of the original export demand.The new export demand is therefore,Q′e0.6Qe0.6(1544176P)926.4105.6P.Graphically, export demand has pivotedinward as illustrated in the figure below.The new total demand becomesQ′QDQ′e(1700107P)(926.4105.6P)2626.4212.6P.Equating total supply and the new total demand,1944207P2626.4212.6P, orP$1.63,which is a significant drop from the original market-clearing price of $2.65 per bushel.At thisprice, the market-clearing quantityis aboutQ2281 million bushels. Total revenue hasdecreased from about $6609 million to $3718 million, so farmers have a lot to worry about.

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20Pindyck/Rubinfeld, Microeconomics,NinthEditionb.Now suppose the U.S. government wants to buy enough wheat to raise the price to $3.50 perbushel.With the drop in export demand, how much wheat would the government have tobuy?How much would this cost the government?With a price of $3.50, the market is not in equilibrium.Quantity demanded and supplied areQ′2626.4212.6(3.50)1882.3, andQS1944207(3.50)2668.5.Excess supply is therefore 2668.51882.3786.2 million bushels.The government mustpurchase this amount to support a price of $3.50, and will have to spend $3.50(786.2 million)$2751.7 million.6.The rent control agency of New York City has found that aggregate demand isQD1608P.Quantity is measured in tens of thousands of apartments.Price, the average monthly rentalrate, is measured in hundreds of dollars.The agency also noted that the increase inQat lowerPresults from more three-person families coming into the city from Long Island and demandingapartments.The city’s board of realtors acknowledges that this is a good demand estimate andhas shown that supply isQS707P.a.If both the agency and the board are right about demand and supply, what is the free-market price?What is the change in city population if the agency sets a maximum averagemonthly rent of $300 and all those who cannot find an apartment leave the city?Set supply equal to demand to find the free-market price for apartments:1608P707P, orP6,which means the rental price is $600 since price is measured in hundreds of dollars.Substitutingthe equilibrium price into either the demand or supply equation to determine the equilibriumquantity:QD1608(6)112andQS707(6)112.The quantity of apartments rented is 1,120,000 sinceQis measured in tens of thousands ofapartments.If the rent control agency sets the rental rate at $300, the quantity supplied wouldbe 910,000 (QS707(3)91), a decrease of 210,000 apartments from the free-marketequilibrium.Assuming three people per family per apartment, this would imply a loss in citypopulation of 630,000 people.Note: At the $300 rental rate, the demand for apartments is1,360,000 units, and the resulting shortage is 450,000 units (1,360,000910,000).However,excess demand (the shortage) and lower quantity demanded are not the same concept.Theshortage of 450,000units is the difference between the number of apartments demanded at thenew lower price (including the number demanded by newpeople who would have moved intothe city), and the number supplied at the lower price.But these new people will not actuallymove into the city because the apartments are not available.Therefore, the city population willfall by 630,000, which is due to the drop in the number of apartments available from 1,120,000(the old equilibrium value) to 910,000.

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Chapter2The Basics of Supply and Demand21b.Suppose the agency bows to the wishes of the board and sets a rental of $900 per month onall apartments to allow landlords a “fair” rate of return.If 50%of any long-run increasesin apartment offerings come from new construction, how many apartments are constructed?At a rental rate of $900, the demand for apartments would be 1608(9)88, or 880,000 units,which is 240,000 fewer apartments than the original free-market equilibrium number of1,120,000.Therefore, no new apartments would be constructed.7.In 2010, Americans smoked 315 billion cigarettes, or 15.75 billion packsof cigarettes.Theaverage retail price (including taxes) was about $5.00 per pack.Statistical studies have shownthat the price elasticity of demand is0.4, and the price elasticity of supply is 0.5.a.Using this information, derive linear demandandsupply curves for the cigarette market.Let the demand curve be of the formQabPand the supply curve be of the formQcdP,wherea,b,c, anddare positive constants.To begin, recall the formula for the price elasticity ofdemand.DPPQEQPWe know the demand elasticity is–0.4,P5, andQ15.75, which means we can solve for theslope,−b, which isQ/Pin the above formula.50.415.7515.750.41.26.5QPQbP   To find the constanta, substitute forQ,P, andbin the demand function to get 15.75a1.26(5),soa22.05.The equation for demand is thereforeQ22.051.26P.To find the supply curve,recall the formula for the elasticity of supply and follow the same method as above:50.515.7515.750.51.575.5SPPQEQPQPQdPTo find the constantc, substitute forQ,P, anddin the supply function to get 15.75c1.575(5)andc7.875.The equation for supply is thereforeQ7.8751.575P.b.In 1998, Americans smoked 23.5 billion packs cigarettes, and the retail price was about$2.00 per pack.The decline in cigarette consumption from 1998 to 2010 was due in part togreater public awareness of the health hazards from smoking, but was also due in part tothe increase in price.Suppose that theentire declinewas due to the increase in price.Whatcould you deduce from that about the price elasticity of demand?Calculate the arc elasticity of demand since we have a range of prices rather than a single price.The arc elasticity formula isPQ PEP Q 

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22Pindyck/Rubinfeld, Microeconomics,NinthEditionwherePandQare average price and quantity,respectively.The change in quantity was15.7523.57.75, and the changein price was 523.The average price was (25)/23.50,and the average quantity was (23.515.75)/219.625.Therefore, the price elasticity ofdemand, assuming that theentire declinein quantity was due solely to the price increase, was 7.753.500.46.319.625PQ PEP Q8.In Example 2.8 we examined the effect of a 20%decline in copper demand on the price ofcopper, using the linear supply and demand curves developed in Section 2.6. Suppose the long-run price elasticity of copper demand was0.75 instead of0.5.a.Assuming, as before, that the equilibrium price and quantity areP*$3 per poundandQ*18 million metric tons per year, derive the linear demand curve consistent with thesmaller elasticity.Following the method outlined in Section 2.6, solve for a and b in the demand equationQDabP.Becausebis the slope, we can usebrather thanQ/Pin the elasticityformula.Therefore,* .*DPEbQ HereED0.75 (the long-run price elasticity),P*3andQ*18.Solving forb,30.75,18b  orb0.75(6)4.5.To find the intercept, we substitute forb,QD(Q*), andP(P*) in the demand equation:18a4.5(3), ora31.5.The linear demand equation is thereforeQD31.54.5P.b.Using this demand curve, recalculate the effect of a 55%decline in copper demand on theprice of copper.The newdemand is 55%below the original (using our convention that quantity demanded isreduced by 55% at every price); therefore, multiply demand by 0.45 because the new demand isonly 45%of the original demand:Equating this to supply,14.1752.025P99P, soP$2.10.With the 55%decline in demand, the price ofcopper falls from $3.00 to $2.10per pound.Thedecrease in demand therefore leads to a drop in price of 90 cents per pound, a 30%decline.

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Chapter2The Basics of Supply and Demand239.In Example 2.8 (page 52), we discussed the recent declinein world demand for copper, due inpart to China’s decreasingconsumption.What would happen, however, if China’s demandwere increasing?a.Using the original elasticities of demand and supply (i.e.,ES1.5 andED0.5), calculatethe effect of a 20%increasein copper demand on the price of copper.The original demand isQ273Pand supply isQ99Pas shown on page 51.The20%increase in demand means that the new demand is 120%of the originaldemand,so thenewdemand isQD1.2Q.QD(1.2)(273P)32.43.6P.The new equilibrium is whereQDequals the original supply:32.43.6P99P.The new equilibrium price isP*$3.29 per pound.An increase in demand of 20%, therefore,entails an increase inprice of 29 cents per pound, or 9.7%.b.Now calculate the effect of this increase in demand on the equilibrium quantity,Q*.Using the new price of $3.29 in the supply curve, the new equilibrium quantity isQ*99(3.29)20.61 million metric tons per year, an increase of 2.61 million metric tons (mmt)per year.Except for rounding, you get the same result by plugging the new price of $3.29 intothe new demand curve.So an increase in demand of 20%entails an increase in quantityof 2.61 mmt per year, or 14.5%.c.As we discussed in Example 2.8, the U.S. production of copper declined between 2000 and2003.Calculate the effect on the equilibrium price and quantity ofbotha 20%increase incopper demand (as you just did in part a)andof a 20%declinein copper supply.The new supply of copper falls (shifts to the left) to 80%of the original, soQS0.8Q(0.8)(99P)7.27.2P.The new equilibrium is whereQDQS.32.43.6P7.27.2PThe new equilibrium price isP*$3.67 per pound.Plugging this price into the new supplyequation, the new equilibrium quantity isQ*7.27.2(3.67)19.22 million metric tonsper year.Except for rounding, you get the same result if you substitute the new price into thenew demand equation.The combined effect of a 20%increase in demand and a 20%decreasein supply is that price increases by 67 cents per pound, or 22%, and quantity increases by 1.22mmt per year, or 6.8%, compared to the original equilibrium.10.Example 2.9 (page 54) analyzes the world oil market.Using the data given in that example:a.Show that the short-run demand and competitive supply curves are indeed given byD36.750.035PSC21.850.023P.The competitive (non-OPEC)quantitysupplied isScQ*23.The general form for the linearcompetitive supply equation isSCcdP.We can write the short-run supply elasticity asESd(P*/Q*).SinceES0.05,P*$50, andQ*23, 0.05d(50/23).Henced0.023.Substituting ford,Sc, andPin the supply equation,c21.85, and the short-run competitivesupply equation isSc21.850.023P.

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24Pindyck/Rubinfeld, Microeconomics,NinthEditionSimilarly, world demand isDabP, and the short-run demandelasticity isEDb(P*/Q*),whereQ*is total world demand of 35.Therefore,0.05b(50/35), andb0.035.Substitutingb0.035,D35, andP50in the demand equation gives 35a0.035(50), so thata36.75.Hence the short-run world demand equation isD36.750.035P.b.Show that the long-run demand and competitive supply curves are indeed given byD45.50.210PSC16.10.138P.Do the same calculations as above but now using the long-run elasticities,ES0.30 andED0.30:ESd(P*/Q*) andEDb(P*/Q*), implying 0.30d(50/23) and0.30b(50/35).Sod0.138andb0.210.Next solve forcanda:SccdPandDabP, implying 23c0.138(50) and 35a0.210(50).Soc16.1anda45.5.c.In Example2.9 we examined the impact on price of a disruption of oil from Saudi Arabia.Suppose that instead of a decline in supply, OPEC productionincreasesby 2 billion barrelsper year (bb/yr) because the Saudis open large new oil fields.Calculate the effect of thisincrease in production on the supply of oil in both the short run and the long run.OPEC’s supply increases from 12 bb/yr to 14bb/yr as a result.Add 14bb/yr to the short-runand long-run competitive supply equations.The new total supply equationsare:Short-run:ST14Sc1421.850.023P35.850.023P, andLong-run:ST14Sc1416.10.138P30.10.138P.These are equated with short-run and long-run demand, so that:35.850.023P36.750.035P, implying thatP$15.52in the short run, and30.10.138P45.50.210P, implying thatP$44.25in the long run.In theshort run, total supply is 35.850.023(15.52)36.21bb/yr.In the long run, total supplyremainsthe same at 30.10.138(44.25)36.21bb/yr.Compared to current total supply of 35bb/yr, supply increases by 1.21bb/yr.11.Refer to Example 2.10 (page 59), which analyzes the effects of price controls on natural gas.a.Using the data in the example, show that the following supply and demand curves describethe market for natural gas in 2005–2007:Supply:Q15.900.72PG0.05PODemand:Q0.021.8PG0.69POAlso, verify that if the price of oil is $50, these curves imply a free-market price of $6.40 fornatural gas.To solve this problem, apply the analysis of Section 2.6 using the definition of cross-priceelasticity of demand given in Section 2.4.For example, the cross-priceelasticity of demandfor natural gas with respect to the price of oil is:.GOGOOGQPEPQ 

Solution Manual for Microeconomics, 9th Edition - Page 28 preview image

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Chapter2The Basics of Supply and Demand25GOQPis the change in the quantity of natural gas demanded because of a small change inthe price of oil, and for linear demand equations, it is constant.If we represent demand as–GGOQabPeP(notice that income is held constant), then.GOQePSubstituting this intothe cross-price elasticity,**,OGOGPEeQwhere*OPand*GQare the equilibrium price and quantity.We know that*$50oPand*23GQtrillion cubic feet (Tcf).Solving fore,501.5,23eore0.69.Similarly, representing the supply equation as,GGOQcdPgPthe cross-price elasticity ofsupply is**,OGPgQwhich we know to be 0.1.Solving forg,23501.0g, org0.5 rounded toone decimal place.We know thatES0.2,PG*6.40, andQ*23.Therefore,2340.62.0d, ord0.72.Also,ED0.5, so2340.65.0b, and thusb1.8.By substituting these values ford, g, b, andeinto our linear supply and demand equations, wemay solve forcanda:23c0.72(6.40)0.05(50), soc15.9, and23a1.8(6.40)0.69(50), so thata0.02.Therefore, the supply and demand curves for natural gas are as given.If the price of oil is $50,these curves imply a free-market price of $6.40 for natural gas as shown below.Substitute theprice of oil in the supply and demand equations.Then set supply equal to demand and solve forthe price of gas.15.90.72PG0.05(50)0.021.8PG0.69(50)18.40.72PG34.521.8PGPG$6.40.b.Suppose the regulated price of gas were $4.50 per thousand cubic feet instead of $3.00.Howmuch excess demand would there have been?With a regulated price of $4.50 for natural gas and the price of oil equal to $50 per barrel,Demand:QD0.02−1.8(4.50)0.69(50)26.4, andSupply:QS15.90.72(4.50)0.05(50)21.6With a demand of 26.4 Tcf and a supply of 21.6 Tcf, there would be an excess demand (i.e., ashortage) of 4.8 Tcf.

Solution Manual for Microeconomics, 9th Edition - Page 29 preview image

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26Pindyck/Rubinfeld, Microeconomics,NinthEditionc.Suppose that the market for natural gas remained unregulated.If the price of oil hadincreased from $50 to $100, what would have happened to the free-market price ofnatural gas?In this caseDemand:QD0.021.8PG0.69(100)69.021.8PG, andSupply:QS15.90.72PG0.05(100)20.90.72PG.Equating supply and demand and solving for the equilibrium price,20.90.72PG69.02–1.8PG, orPG$19.10.The free-market price of natural gas would have almost tripled from $6.40 to $19.10.12.The table below shows the retail price and sales for instant coffee and roasted coffee for twoyears.YearRetail Price ofInstant Coffee($/LB)Sales of InstantCoffee(Million LBs)Retail Price ofRoasted Coffee($/LB)Sales ofRoasted Coffee(Million LBs)Year 110.35754.11820Year 210.48703.76850a.Using these data alone, estimate the short-run price elasticity of demand for roasted coffee.Derive a linear demand curve for roasted coffee.To find elasticity, first estimate the slope of the demand curve:8208503085.74.113.760.35QP Given the slope, we can now estimate elasticity using the price and quantity data from the abovetable.Assuming the demand curve is linear, the elasticity will differbetweenthe two yearsbecause price and quantity are different.We can calculate the elasticities at both points and alsofind the arc elasticity at the average point between the two years:   124.11( 85.7)0.0438203.76 ( 85.7)0.0388503.935 ( 85.7)0.040.835PPARCPPQEQPPQEQPPQEQPTo derive the demand curve for roasted coffee,QabP, note that the slope of the demandcurve is85.7b.To find the coefficienta, use either of the data points from the table aboveso that 820a85.7(4.11) or 850a85.7(3.76).In either case,a1172.2.The equation forthe demand curve is thereforeQ1172.285.7P.

Solution Manual for Microeconomics, 9th Edition - Page 30 preview image

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Chapter2The Basics of Supply and Demand27b.Now estimate the short-run price elasticity of demand for instant coffee.Derive a lineardemand curve for instant coffee.To find elasticity, first estimate the slope of the demand curve:7570538.510.3510.480.13QP Given the slope, we can now estimate elasticity using the price and quantity data from the abovetable.Assuming demand is of the formQa−bP, the elasticity will differ in the two yearsbecause price and quantity are different.The elasticities at both points and at the average pointbetween the two years are:1210.35 ( 38.5)5.317510.48 ( 38.5)5.767010.415 ( 38.5)5.53.72.5PPARCPPQEQPPQEQPPQEQP   To derive the demand curve for instant coffee, note that the slope of the demand curveis38.5b.To find the coefficienta,use either of the data points from the table aboveso thata7538.5(10.35)473.5 ora7038.5(10.48)473.5.The equation forthedemand curve is thereforeQ473.538.5P.c.Which coffee has the higher short-run price elasticity of demand?Why do you think this isthe case?Instant coffee is significantly more elastic than roasted coffee.In fact, the demand for roastedcoffee is inelastic and the demand for instant coffee is highly elastic.Roasted coffee may havean inelastic demand in the shortrun because many people think of coffee as a necessary good.Changes in the price of roasted coffee will not drastically affect the quantity demanded becausepeople want their roasted coffee.Many people, on the other hand, may view instant coffee as aconvenient, though imperfect and somewhat inferior, substitute for roasted coffee.So if the priceof instant coffee rises, the quantity demanded will fall by a large percentage because manypeople will decide to switch to roasted coffee instead of paying more for a lower qualitysubstitute.

Solution Manual for Microeconomics, 9th Edition - Page 31 preview image

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