# Economics Homework 3 - Model

1. What is a substitute for French fries, and what is a complement for them?

Substitutes: hash browns, fruit, baked potato, salad, etc.
Complements: hamburger, ketchup, sauce, etc.

2. Give an example of a good that has a large price elasticity, meaning that a small decrease in price causes a big increase in demand.

Candy bars, iPhone, most electronics, etc.

3. Explain the concept of income elasticity.

Income elasticity measures how much the overall demand for a good increases (or decreases) due to an increase in the income of the public. For luxury goods, their income elasticity is high: demand increases a great deal when the income of the public increases. For basic necessities like toothpaste, their income elasticity is low: people need to buy it whether they have a good job or not.

4. In connection with price elasticity of demand, a nearly perfectly elastic demand curve is nearly ________ in shape, while a nearly perfectly inelastic demand curve is nearly __________ in shape.

horizontal ... vertical. Nearly perfectly elastic demand curve means that a small change in price (graphed on the Y-axis) means a big change in quantity demanded (graphed on the X-axis), which is a nearly horizontal line. Conversely, a nearly perfectly inelastic demand curve means that a big change in price causes a small change in quantity demanded, which is a nearly vertical line with P on the Y-axis and Q on the X-axis.

5. Why is the name "necessity" given to a good that has an income elasticity of less than one, and the name "luxury" given to a good that has an income elasticity of more than one?

Because changes in income do not have much affect on the quantity demanded for the goods we need - they are "necessary" whether we have lots of income or not. But for goods that see their demand change a great deal based on income, they are not necessary to life and thus are called "luxuries".

6. Give an example of a "normal" good, and an example of an "inferior" good.

Electronics such as iPhones are "normal" goods. An inferior good would be used bicycles.

7. A "price ceiling" is a type of price control that sets the maximum price allowed by law for something (like a real ceiling). A "price floor" is a type of price control that sets a minimum price allowed by law for something (like a real floor). Does a price ceiling that is set below the equilibrium (free market) price cause a surplus or a shortage? Using the graph in this lecture, explain why a surplus or a shortage is created by a price ceiling.

A price ceiling causes a shortage because it both reduces supply (fewer people want to produce the good to sell at the low price) and increases demand (more people want to buy the good at the low price).