Economics Homework Three - Model

1. 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.

2. Explain the concept of income elasticity.

Income elasticity is defined as the percent change in quantity divided by the percent change in income, explaining the fact that as a person's income decreases, they have a lower demand for most goods--they cannot afford as much--and the corollary concept: when their income increases, the demand increases. Goods where the demand decreases when income increases are inferior goods, less desirable substitutes for something. A used car is an inferior good. (Duncan)

Income elasticity deals with the change in demand for a good based on buyers’ incomes. A good is considered “income elastic” if demand significantly decreases when incomes decrease. A good is considered “income inelastic” if demand remains roughly the same when incomes decrease. Necessary or basic goods are income inelastic because everyone, regardless of income, needs them (demand will still decrease but not very much); “luxury” or essentially unnecessary goods are income elastic. (Addison)

3. A nearly perfectly elastic demand curve is nearly ________ in shape; a nearly perfectly inelastic demand curve is nearly __________ in shape.

A nearly perfectly elastic demand curve is nearly flat. A nearly perfectly inelastic demand curve is nearly vertical. (Mark)

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

When the price elasticity is low, generally it is a good that people need, such as food, fuel, or shelter, and will pay more for. In the equation, the change in Q is a smaller number than the change in P, so it is a proper fraction (<1). A luxury is something that people want, not really need, so they can do without it if the price goes up. The change in Q is larger than the change in P, so it will be an improper fraction (>1). (Aran)

5. What is a substitute for french fries, and what is a complement for them?

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

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.

Honors

Write an essay of about 200-300 words total on one or more of the following topics:

8. Take a straight line demand curve and describe the shape of the total revenue curve as a function of price.

9. Explain price discrimination, and conclude with your view of whether it should be legal or illegal.

Price discrimination is the act of selling two identical goods to two different people, charging different prices for the two sales. It is technically illegal, as many feel it is unfair for a supplier to "exploit" one person by charging more, but it still goes on under the guise of different tricks. For example, at a ski mountain in Vermont where we usually go for a week in the winter, there are two classes of lift ticket for over-18s: Adult and Vermonter; a Vermonter ticket (which requires residence in the state) is 20% less than a normal one.

Price discrimination should not be illegal; the resale market for most goods prevents it (if a merchant sold a rug to one person for $2000 and to another for $2500, the one who got the better price would simply buy more rugs than he needed and resell them at a price lower than $2500 and more than $2000. For items such as lift tickets or a sweatshirt with your name on it, you cannot resell it, and the sellers, if discrimination is illegal, will simply find ways around it, as described above. Finally, poorer people will most likely get a better deal on things, as sellers know they cannot afford as high a price as the richer. (Duncan)

10. Do you support "free trade" because it creates wealth, or do you oppose it for simply redistributing wealth to foreigners, some hostile to the United States?

11. What is your view of the minimum wage? Should it be increased?

12. Describe and discuss how wealth is created in society.