# Problem Set 3Solution

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Problem Set 3_Solution 1. Suppose that the price of basketball tickets at your college is determined by market forces. Currently, the demand and supply schedules are as follows: a. Draw the demand and supply curves. What is unusual about this supply curve? Why might this be true? As the above Figure shows, the supply curve is vertical. The constant quantity supplied makes sense because the basketball arena has a fixed number of seats at any price. b. What are the equilibrium price and quantity of tickets? Quantity supplied equals quantity demanded at a price of \$8. The equilibrium quantity is 8,000 tickets. c. Your college plans to increase total enrollment next year by 5,000 students. The additional students will have the following demand schedule:
Now add the old demand schedule and the demand schedule for the new students to calculate the new demand schedule for the entire college. What will be the new equilibrium price and quantity? Price Quantity Demanded Quantity Supplied \$4 14,000 8,000 \$8 11,000 8,000 \$12 8,000 8,000 \$16 5,000 8,000 \$20 2,000 8,000 The new equilibrium price will be \$12, which equates quantity demanded to quantity supplied. The equilibrium quantity remains 8,000 tickets. 2. Suppose that business travelers and vacationers have the following demand for airline tickets from San Antonio to Houston: a. As the price of tickets rises from \$200 to \$250, what is the price elasticity of demand for (i) business travelers and (ii) vacationers? For business travelers, the price elasticity of demand when the price of tickets rises from \$200 to \$250 is [(1,900-2,000)/2000]/[(250 - 200)/200] =-0.05/0.25 = -0.2. For vacationers, the price elasticity of demand when the price of tickets rises from \$200 to \$250 is [(600-800)/800] / [(250 - 200)/200] =-0.25/0.25 = -1.
b. Why might vacationers have a different elasticity from business travelers? The absolute value of price elasticity of demand for vacationers is higher than the elasticity for business travelers because vacationers can choose a substitute more easily than business travelers. For example, vacationers can choose a different mode of transportation (like driving or taking the train), a different destination, a different departure date, and a different return date. They may also choose to not travel at all. Business travelers are less likely to do so because their schedules are less adaptable. 3. Cups of coffee and donuts are complements. Both have inelastic demand. A hurricane destroys half the coffee bean crop. Use appropriately labeled diagrams to answer the following questions. a. What happens to the price of coffee beans? The effect on the market for coffee beans is shown in the Figure below. When a hurricane destroys half of the crop, the supply of coffee beans decreases, the price of coffee beans increases, and the quantity decreases. b. What happens to the price of a cup of coffee? What happens to total expenditure on cups of coffee? The effect on the market for cups of coffee is shown in the Figure of part a. When the price of coffee beans, an important input into the production of a cup of coffee, increases, the supply of cups of coffee decreases, the price of a cup of coffee increases, and the quantity decreases. Because cups of coffee have an inelastic demand, when the price of a cup of coffee increases, the total expenditure on coffee increases. c. What happens to the price of donuts? What happens to total expenditure on donuts?