Problem Set No. 1

Problem 1

The demand and supply schedules for milk are as follows:

Price Quantity Demanded Quantity Supplied
$10 0 125
8 20 95
6 40 65
4 60 35
2 80 5

a. On the same graph, draw the demand and supply curves. What does the demand curve for a product describe? What does the supply curve for a product describe? (Be specific.)


b. Use your graph to identify the equilibrium price and quantity. Explain why this is an equilibrium point.


c. Suppose that the federal dairy program fixes the price at $7.00. Explain, referring to your graph, what will happen to the milk market.


d. Suppose a welfare program increases demand for milk by 50 percent at all price levels. Graph the new demand curve. What is the new equilibrium? What happens to supply? What happens to the quantity supplied?


e. Genetic engineering has lead to the development of bovine growth hormone. This hormone is expected to dramatically increase the production of milk of each cow. How will this development affect (i) supply, (ii) demand, (iii) quantity supplied, and (iv) quantity demanded?



Problem 2


The disappearance of anchovies off the coast of Peru in 1972 caused a scramble for protein-rich substitutes, notably soybeans. Because soybeans are used in animal feed, higher soybean prices eventually were translated into higher cattle prices.


Use demand and supply diagrams to show what happened in the (i) anchovy, (ii) soybean, and (iii) cattle markets. Indicate which curves shifted in each instance, and show the effects on the equilibrium price and quantity in the relevant market.



Problem 3


Suppose that the demand curve for cantaloups can be described by the equation P = 120 - 3Qd, where P is the price per pound (in cents) of cantaloups and Qd is the quantity demanded per year (in millions of pounds). Furthermore, suppose that the supply curve for cantaloups is P = 5Qs, where Qs is the quantity supplied per year (in millions of pounds).


What is the equilibrium price per pound for cantaloups? What is the equilibrium quantity of cantaloups produced?



Problem 4


For home-owning families in the 35 percent income tax bracket, the deductibility of mortgage payments and property taxes reduces the effective price of owner-occupied housing by roughly 25 percent.


If the elasticity of demand for housing is -1.2, what will happen to the quantity of housing demanded if this governmental subsidy is removed? Specifically, by what percentage will the quantity demanded change?



Problem 5


Originally the price of a product was $6.00. Total sales (total consumer expenditures) for this product were $600,000 per month.


Due to a shift in supply, the price increased to $6.06. Total monthly sales in the market then fell to $594,000.


a. What is the elasticity of demand for this product?


b. Can you also calculate the elasticity of supply from the information that you have?


c. On a graph, show the two equilibria. Be sure to label both sets of equilibrium prices and quantities (graphical precision is not necessary).


Also, on the same graph, diagram total consumer expenditures in each situation.