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Explanation & Answer
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Dr. Stephen Miller
Spring 2020
ECO 6655
Review Questions for Exam I
1. Suppose the demand for shoelace eyelets is represented by the equation:
D = 60-p, where p is price, and that supply is represented by the equation S=10+2p-w,
where w is the wage rate for eyelet factory workers.
a) Assuming the market wage rate is $10/hour, what is the equilibrium price? What
is the equilibrium quantity?
Demand,
Supply,
D
S
= 60 – p
= 10 + 2p – w
Where;
p
= Price
w
= wage
At equilibrium,
D=S
Assumption; w
= $10/hr.
Therefore,
60 – p = 10 + 2p -10
60 – p = 2p
3p = 60
p = 20
Equilibrium price, Pe
Equilibrium Quantity, Qe
= $20/hr.
= D = 60 – p
= 60 - 20
= 60 - 20
= 40 units
b) What are the equilibrium price and quantity if the wage increases to $16/hr?
Demand,
Supply,
D
S
At equilibrium,
D=S
= 60 – p
= 10 + 2p – w
Assumption; w
= $16/hr.
Therefore,
60 – p = 10 + 2p -16
66 – p = 2p
3p = 66
p = 22
Equilibrium price, Pe
Equilibrium Quantity, Qe
= $22/hr.
= D = 60 – p
= 60 - 22
= 60 - 22
= 38 units
c) Use the changes in price and quantity demanded above to calculate the price
elasticity
Price Elasticity
=
(% Change in Quantity)/ (%Change in Price)
% Change in Quantity
=
(38 – 40)/40 * 100%
=
-5%
%Change in Price
=
=
=
%Change in Price
(22– 20)/20 * 100%
10%
Price Elasticity
=
=
-5/10
-0.5
Price Elasticity is indicative of the relative movement of quantity demanded with respect
to changes in prices. In this case, it shows the changes in eyelet demanded with respect to
price changes.
As calculated above, price elasticity is negative 0.5. Thus, we can say that for every
percentage point that eyelet prices increase, the quantity of eyelets purchased decreases
by half percentage point. The changes in prices are dependent on changes in wages which
is an indirect relationship.
Therefore, eyelets follow the law of demand and supply.
d) of demand. Interpret your result (i.e. what does the elasticity you calculate
mean?).
Price Elasticity is indicative of the relative movement of quantity demanded with respect
to c...