Professional Documents
Culture Documents
Milo McClausland, Alexander Rhoads, William Kennedy, Kevin Bae, Bhavik Mistry
1. If the demand for sugar decreases when the price of tea increases, are tea and sugar
complements, substitutes or unrelated to each other? Explain.
Sugar and tea would be complements of each other. When the price of tea increases, the
demand for tea decreases and from the given data the demand for sugar also decreases.
The scenario above gives us two goods for which an increase in the price of one leads to a
decrease in the quantity demanded of the other.
2. Researchers have just discovered that antibacterial agents in toothpaste are harmful
to human health. At the same time, the price of toothpaste-making equipment has
fallen. What definitely happens in the toothpaste market after these events occur (i.e.,
what are the new equilibrium price and quantity of toothpaste? Higher, lower, or the
same)? Show with graphs.
We assume that the researchers negative
discovery regarding toothpaste will lead to
a sharp drop in demand for the product.
Supply however will increase slightly
because it now costs less for firms to enter
the industry due to equipment prices
falling. So, new equilibrium price and the
quantity of toothpaste will be lower than
before as shown in the graph to the left.
3. When you left your job at McDonalds, you expected that your days of dealing with
potatoes were over. Yet, given your extensive potato background, and armed with an
MBA from the prestigious McDonough School of Business at Georgetown, you are
hired as a market analyst in, of all things, the potato market. For the last several years,
production, demand and prices have been stable. Last year the quantity of potatoes
transacted in the United States was 450 million cwt (cwt is agriculture-speak for 100
pounds), and prices were $8MM per million cwt. Econometric estimates have
determined that, at this level, the own-price point elasticity of demand is 0.8.
a. Assume that demand is linear. Derive the slope and intercept of Q D(P), a linear
demand function.
We are given
P = $8MM per million cwt,
Q = 450 million cwt,
Own Price Point Elasticity of Demand = - 0.8 (minus sign because the demand curve is
downward sloping)
Therefore, in order to derive the slope we use the formula
= Slope x Price/Demand
- 0.8 = Slope x 8/450
Therefore, slope of QD(P) = - 45
We then need to plug the slope into the equation
1|Page
c. A marketing campaign touting the health benefits of rice has produced a recent
forecast that the demand for potatoes will fall over the next year by 20 percent. If
this report is accurate, what would the new equilibrium price for potatoes be?
Assume that the supply curve is given by QS(P) = 56.25P.
Because the demand decreases by 20% we assume that:
QD(P)2 = (1 - 0.2) x QD(P)1
QD(P)2 = 0.8 x (20,258 P) / 45
QD(P)2 = 360.14 0.0178P
And QS(P) = 56.25P
Now, to find the equilibrium price,
QS(P) = QD(P)2
So,
56.25P = 360.14 0.0178P
56.2678P = 360.14
Therefore, P = 6.4
So, the new equilibrium price for potatoes is $6.4MM per million cwt
2|Page
3|Page