I need detailed answers for these problems. They are core problems to prepare for the exam.
(Gwartney, p. 78, #2) What is being held constant when a demand curve for a specific product (shoes or apples,
for example) is constructed? Explain why the demand curve for a product slopes downward to the right. (We
gave two reasons in class?explain them both.)
2. (McEachern, p. 93, #12) Using demand and supply curves, show the effect of each of the following on the market
a. A curve for lung cancer is found.
b. The price of cigars increases.
c. Wages increase substantially in states that grow tobacco.
d. A fertilizer that increases the yield per acre of tobacco is discovered.
e. There is a sharp increase in the price of matches, lighters, and lighter fluid.
f. More states pass laws restricting smoking in restaurants and public places.
3. The Cash for Clunkers program run by the federal government last year gave consumers approximately a $4,000
rebate on the purchase of a new fuel efficient car if they simultaneously turned in a used car which received less
than 18 miles per gallon. A recent article in the U.S.A. Today (August 10, 2009) notes, "the clunker program
could cause prices [of used cars] to rise 5% to 10% ... says Alec Gutierrez, senior market analyst for Kelley Blue
Book. 'It's going to drive prices up of some of the most affordable vehicles we have on the road.'" The article
notes that the price rise is not only due to the government program but also to weak economic conditions
(consumers' real incomes are down).
a. Illustrate how (i) the government program and (ii) lower consumer income affect the market for used cars
using a supply and demand diagram. What can you say about the price of used cars? What about the
quantity bought and sold?
b. What if this program took place in a strong economy (consumers' real incomes were higher) instead of a
weak one. Now what could you say about the price of used cars and the quantity bought and sold?
4. (Based on Gwartney, p. 103, #8) Even though it is illegal to buy and sell kidneys in the United States, we can still
talk about the "market" for these organs.
a. Draw the demand curve for kidneys and the supply curve of kidneys on one graph. Do they obey the laws
of supply and demand? Then show the effects of a ban on the buying and selling of kidneys (Hint: this is
equivalent to a price ceiling.)
b. How do you think the market for kidneys would be affected if it was made fully legal with a well-functioning
price mechanism? What would be the advantages and disadvantages relative to the current
5. (Mankiw, p. 111, #9) The New York Times reported (Feb. 17, 1996) that subway ridership declined after a fare
increase: "There were nearly four million fewer riders in December 1995, the first full month after the price of a
token increased 25 cents to $1.50, than in the previous December, a 4.3 percent decline."
a. Use these data to estimate the price elasticity of demand for subway rides.
b. According to your estimate, what happens to the Transit Authority's revenue when the fare rises?
c. Why might your estimate of the elasticity be unreliable?
1. When a demand curve is constructed, all factors are held constant except for price. The downward slope is due to the income and substitution effects. The income effect tells us that as the price of the good increases, we expect fewer people to be able to afford it. Due to the increase in price, they have less to spend, even though their nominal incomes are the same. The substitution effect tells us that as consumers seek to maximize utility, substitute goods look more appealing when the price of a good increases. These substitute goods have become relatively less expensive.
a. If lung cancer were curable, the demand for cigarettes would increase (demand curve shifts outward).
b. No change in either curve (price changes are already factored into both curves).
c. Increase in the cost of an input causes an ...
Markets for human organs; the cash for clunkers program; and a discussion of market mechanisms in general.