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Flashcards in Module 3 - Demand Deck (34):
1

The concept of demand is described by

I. how fully a good satisfies an individual’s wants.

II. how much of a good an individual would be prepared to buy.
Which of the following is correct?

A. I only.
B. II only.
C. Both I and II.
D. Neither I nor II.

The correct answer is B. How fully a good satisfies an individual’s wants will be determined by the total quantity of that good which the individual consumes. The demand curve that embodies the concept of demand yields information on how much an individual would be prepared to pay for an additional unit of the good cet. par., i.e. it does not yield information on total satisfaction obtained from the good.

2

In a household with a given food budget, factors that will affect how fully the family’s

wants for food are satisfied are
I. the prices of foodstuffs.
II. the prices of non-foodstuffs.
III. total household income. Which of the following is correct?

A. I only.
B. I and II only.
C. I, II and III.
D. Not I, not II, not III.

The correct answer is A. How fully a family’s wants for food are satisfied will depend on the quantities of food available, which in turn will depend on the amount of income (budget) allocated to food purchases and on the prices of foodstuffs. Since, in the question, the budget is determined (or given), the only remaining factor that will affect the quantity of foodstuffs that can be purchased is the price of foodstuffs. Had the question been concerned with the satisfaction of all wants, II and III as well as I would have been relevant factors.

3

A traveller arrives at an airport and discovers that the taxi fare to the city centre is $5.00. The additional economic variables that will influence the average individual’s decision whether or not to hire a taxi are

I. the price of the airport bus to the city. 

II. the individual’s income.

III. the price of a new taxi. Which of the following is correct?

A. I only.
B. I and II only.
C. I and III only.
D. I, II and III.

The correct answer is B. The airport bus and the taxi compete for passengers in terms of speed, privacy, convenience and price. These factors, together with the income of passengers, help determine which form of transport is chosen. The taxi fare, not the purchase price of the taxi itself, will affect the decision.

4

In some countries, such as Saudi Arabia, the sale of alcohol is prohibited. Which of the following is correct? It can be concluded that

A. in those countries no individual has any demand for alcohol.
B. law makers in those countries believe that the consumption of alcohol isharmful to society.
C. there are no benefits from drinking alcohol.
D. individuals collectively in those countries have no demand for alcohol.

The correct answer is B. All societies have laws designed to regulate behaviour for the benefit of society as a whole or for individuals within society, e.g. compulsory education and drug control. People often disregard the law and suffer penalties if caught. The existence of laws prohibiting the purchase of goods does not imply that there is no demand for such goods; indeed, the underworld flourishes on illegal markets. Demand theory assumes that individuals know their own interests best and that if a good is bought – legally or illegally – it is because the marginal benefit to the individual exceeds the marginal cost. Economics is not concerned with making moral judgements on what is good or bad for a rational person.

5

A well-known football club is considering allowing old-age pensioners (people over 65 years of age) to attend home games for $2 instead of the normal ticket price of $10. If total ticket receipts were to increase as a result of adopting such a policy, which of the following is correct? It follows that

A. old-age pensioners, as a group, will have more income remaining to spend on other goods and services.

B. the demand for tickets by old-age pensioners is more price-elastic than the demand for tickets by all other age groups taken together.

C. total revenue from ticket sales would increase if all ticket prices were reduced to $2.

D. the increase in ticket revenue from new fans more than offsets the loss in revenue from old-age pensioners, who always attended games but now pay $2 instead of $10.

The correct answer is D. Because total receipts increase when the price is lowered from $10 to $2, it means that ticket sales increase proportionally more than the price decrease, e.g. 100 × $2 > 8 × $10. Thus, in price range $2–$10, the demand for tickets by old-age pensioners is price-elastic. However, we have no corresponding data for spectators of other ages and consequently can make no elasticity compari- son. Nevertheless, the increase in gate receipts means that, as a group, old people will have less to spend on other goods and services; the increase in gate receipts also means that the loss in revenue from original older fans (now paying $2 instead of $10) has been more than compensated for by new fans each paying $2.

6

On a desert island, only two foods are available, fish and coconuts. On some days a castaway eats well; on other days he goes hungry.

On any given day

I. the higher the marginal utilities of fish and coconuts the hungrier he is.
II. the lower the marginal utilities of fish and coconuts the hungrier he is.
III. when the marginal utilities are zero, his total utility is zero. Which of the following is correct?

A. I only.
B. II only.
C. I and III only.
D. II and III only.

The correct answer is A. The more an individual consumes of a good, the higher will be total utility and the lower will be marginal utility of that good.

7

A person spending his income to yield maximum satisfaction buys hot dogs at 25 cents each and glasses of beer at 50 cents each. He derives 40 utils (units of utility) from the fourth and last hot dog he buys. How many utils does he derive from the last glass of beer he buys in the same period?

A. 20.
B. 40.
C. 80.
D. 160.

The correct answer is C. This is a purely arithmetical question. If a utility- maximising individual in a two-good world is in equilibrium, and if the price of one good is double that of a second good, the marginal utility of the first good must also be double that of the second good. (Rework the example with the price of a glass of beer set at $1 and make sure you understand why option D would be correct.)

8

In a village in Ireland in the nineteenth century, all income was earned by producing linen and all family income was spent on food. When the price of meat fell, family F bought fewer potatoes and said it was better off. Family G said it was neither better nor worse
off in the same circumstances. Assuming the ‘law of diminishing marginal utility’ to hold, it follows that

I. family F’s marginal utility of meat must have fallen.

II. family G must not have consumed any meat either before or after the price change. Which of the following is correct?

A. I only.
B. II only.
C. Both I and II.
D. Neither I nor II.

The correct answer is C. After the fall in the price of meat, Family F said it was better off despite having bought fewer potatoes, therefore Family F must have bought more meat. However, as more of a good is consumed in a given period, its marginal utility decreases; therefore for Family F the marginal utility of meat must have fallen. The only way in which Family G could not have benefited from the decrease in the price of meat is if Family G purchased no meat before or after the fall in price.

9

A consumer’s typical demand curve is downward sloping to the quantity axis because

I. at lower prices the consumer buys more of the good in question in place of other goods that are now relatively more expensive.

II. at lower prices the consumer can buy all she bought of the good at the higher price, and with the money left over she can still buy more.

Which of the following is correct?

A. I only
B. II only
C. Both I and II
D. Neither I nor II

The correct answer is C. Income and substitution effects explain why, in economic theory, demand curves are negatively inclined to the price axis. If the price of a good bought by a consumer decreases, cet. par., the consumer will experience a rise in real income. This enables the consumer to increase purchases of all goods. Further, since the decrease in the price of the one good changes relative prices, a utility- maximising consumer will alter purchases by substituting the cheaper good for the now relatively more expensive goods until equilibrium is restored.

10

An individual’s demand curve for beer could shift because of

I. a change in the price of beer.
II. a change in the price of wine.
III. a change in the individual’s income.

Which of the following is correct?

A. I only.
B. I and III only.
C. II and III only.
D. I, II and III.

The correct answer is C. A shift in a demand curve is caused by a change in any of the factors determining the position of the curve – income, prices of other goods, etc. A movement along a demand curve is caused by a change in price.

11

In Figure 3.11 the demand curve for cigarettes could have shifted from DD to D1D1 (assuming cigarettes not to be an inferior good) because of

I. the BMA’s report suggesting a link between cigarette smoking and premature death.
II. a decrease in the price of cigars and pipe tobacco (cigar and pipe smoking being substitutes for cigarette smoking for many people). III. an increase in smokers’ income.

Which of the following is correct?

A. II only.
B. I and II only.
C. I and III only.
D. I, II and III.

The correct answer is B. The three factors mentioned in I, II and III are likely factors determining the position of the demand curve for cigarettes. To the extent that some people pay attention to the BMA report and reduce or stop their smok- ing, DD will shift to the left. Similarly, as people switch from cigarettes to cigars and pipe tobacco as their prices decrease, DD will shift to the left. (For practical purposes we can ignore the extreme example of a person spending almost all his income on tobacco products, who experiences such a large increase in real income when the price of cigars and pipe tobacco fall that he is able to smoke more cigars, pipe tobacco and also cigarettes, i.e. income effect outweighs the substitution effect.) Given cigarettes are a normal good, a higher income would cause DD to shift to the right.

12

If beef is a substitute for lamb and mint jelly is a complementary good to lamb, which of the following is correct? An increase in the price of lamb, cet. par., will lead to

A. a decrease in the quantity of beef demanded.

B. an increase in the quantity of beef demanded and an increase in the quantity of mint jelly demanded.

C. a decrease in the quantity of mint jelly demanded.

D. an increase in the quantity of mint jelly demanded and a decrease in the quantity of beef demanded.

The correct answer is C. A rise in the price of a good will lead to a smaller quantity being purchased, an increase in the purchase of substitute goods and a decrease in the purchase of complementary goods.

13

In travelling about London, most people use either the underground train system or the bus (which are substitutes for one another). Suppose all underground train fares were doubled but bus fares remained unchanged. How would the underground train fare increase affect the total fare revenue?

A. It would increase for buses but might increase or decrease for the underground.

B. It would increase for the underground but might increase or decrease for buses.

C. It would increase for both underground and bus travel.

D. It would increase for the underground and remain unchanged for buses.

The correct answer is A. As underground train fares increase, some people will switch to substitute goods – in this case buses. Thus total bus revenues will increase. Total underground fare revenue will increase if the percentage fare increase exceeds the percentage underground passenger loss, that is, if the demand for underground services in the relevant price range is inelastic. If the demand is price-elastic or of unitary elasticity, underground fare revenue will not increase as underground fares increase. (It is stated that buses and the underground are substitutes. Were they complements, for example if passengers used buses to reach underground stations, then, assuming the demand for the underground is not perfectly inelastic, bus revenue would fall as underground fares increased, because travelling on both would be reduced. Again, underground revenue would rise or fall, depending on the price elasticity of demand.)

14

The local Community Centre operates so as to raise just enough revenue to cover its costs. Its revenue comes from a membership fee of $5 and a price of 50 cents for its nightly disco in the main hall. Attendance at the disco results in overcrowding of the
hall. In order to reduce the crowding without increasing total receipts, if disco demand is elastic and membership demand is inelastic, the Centre should do which of the following:

A. raise both the membership fee and the disco price.
B. lower both the membership fee and the disco price.
C. raise the disco price and lower the membership fee.
D. lower the disco price and raise the membership fee.

The correct answer is A. This is a complicated application of the concept of demand. Since the membership demand is inelastic, raising the price of membership will result in a relatively small reduction in the number of members and an increase in Community Centre revenue. By raising the disco price, total revenue will fall since demand is elastic. Although we do not know the exact figures involved, this policy is on the right lines since the fall in revenue from the disco, which will no longer be overcrowded if a high enough price is charged, will be compensated for by the increased revenues from membership fees.

15

A household can supplement its income in some given time period by
I. using past savings
II. decreasing consumption expenditure
III. borrowing against future income

Which of the following is correct?
A. I only
B. I and III only
C. II only
D. I, II and III

The correct answer is B. Most households have a budget constraint in any given time period, i.e. the amounts of goods and services they can buy are constrained by their incomes. However in any given time period earned income can be supplemented by past savings or borrowing against future income. Thus I and III are true. Decreasing consumption expenditure will increase savings and permit higher income in a future time period but it will not supplement income in the given time period. Thus II is incorrect.

16

If the following equation referred to the current behaviour of a household

MUaPa  MUbPb

What change in consumption would be required to achieve maximum utility from the consumption of the two goods?

A. An increase in consumption of good b thereby raising the total utility of b

B. An increase in consumption of good a and a decrease in consumption of good b thereby decreasing MUa and increasing MUb

C. A decrease in the consumption of good a thereby lowering Pa until the ratios were equal

D. Spending equal amounts on both goods, assuming their prices are equal, will cause the ratios to be equal

The correct answer is B. Reallocation of expenditure towards more of good a and less of good b will cause the MUa to decrease as more is consumed and cause the MUb to increase as less is consumed both because of the Law of Diminishing Marginal Utility. This process should continue until equality is achieved after which any reallocation will decrease total utility.

17

Which of the following represents the Law of Diminishing Marginal Utility

A. A only
B. B only
C. C only
D. D only

The correct answer is C. As an individual consumes more of a good total utility increases but at a decreasing rate, i.e. each additional unit consumed contributes less utility than the previous unit. In figures A and B the lines are straight; this would indicate constant marginal utility (MU). Thus A and B are wrong. In figure D, the slope of the line (change in total utility/change in quantity) i.e. Uincreases as Q increases indicating increasing marginal utility as Q increases. Thus D is wrong. In figure C the opposite occurs; MU decreases as Q increases.

18

Why do economists find the ‘ceteris paribus’ assumption useful in economic analysis? The ‘ceteris paribus’ assumption permits economiststo A. select the variables which affect sales B. isolate inferior goods C. investigate the impact of one variable in isolation D. determine income elasticity of demand

The correct answer is C. In studying demand (or supply) many variables may affect the quantity of a good demanded in a given time period. To measure the influence of any one of those variables it is necessary to hold constant all other variables affecting potential purchases. Failure to do so will make it impossible to calculate how changes in the variable selected will affect demand, e.g. how falling interest rates affect house purchases if falling interest rates occur at the same time as rising wealth due to a boom in the stock market. To investigate one variable in isolation necessitates holding all other factors constant, i.e. the ‘ceteris paribus’ assumption.

19

Which of the following identifies an ‘inferior’ good?

A. When the price decreases less is purchased

B. When real income increases less is purchased

C. When the price increases more is purchased

D. When real income increases the substitution effect is positive

The correct answer is B. This is a definitional question. Inferior goods such as cheap cuts of meat and low quality housing are goods for which the quantities purchased decrease as incomes increase.

20

You are in a fishmongers about to buy salmon and tuna steaks to barbecue for dinner when your daughter contacts you on your mobile to inform you there will be 4 more for dinner. At the same time the fishmonger announces that the tuna steaks are now half price. You decide to forego the salmon steaks – all will have tuna.

Compared to your initial position before the mobile call and fishmonger’s cut price deal on tuna which of the following describes what has occurred to your demand curve for tuna?

There has been
A. a shift to the right of and a movement along your demand curve
B. a shift to the left of but no movement along your demand curve
C. a shift to the left of and a movement along your demand curve
D. a shift to the right of but no movement along your demand curve

The correct answer is A. The arrival of 4 more for dinner necessitates a larger quantity of fish at ‘the going’ price, i.e. a shift to the right of the demand curve. The fall in the price of tuna has two effects: first it is now relatively more attractive than salmon; second, the portion of your budget you were going to allocate to tuna initially will now be able to purchase more tuna. The first effect will shift the demand curve for tuna to the right; the second effect will cause a movement along the curve.

21

You are in a fishmongers about to buy salmon and tuna steaks to barbecue for dinner when your daughter contacts you on your mobile to inform you there will be 4 more for dinner. At the same time the fishmonger announces that the tuna steaks are now half price. You decide to forego the salmon steaks – all will have tuna.

Which of the following diagrams represents what is happening to your demand curve for salmon where D1 is the initial demand curve, i.e. before the guests’ arrival and the price reduction in tuna and D2 is the demand curve after those events.

A. A only
B. B only
C. C only
D. D only

The correct answer is D. Diagram B shows 2 completely price inelastic demand curves so B is wrong. Diagram C shows a positively inclined demand curve D2 so C is wrong. Diagram A indicates 2 salmon steaks are purchased so A is wrong. Diagram D indicates no steaks purchased when the demand curve shifts to the left which it does because of the fall in the price of tuna.

22

The price charged by a famous surgeon in Southern California for facial cosmetic surgery is $20k. At this price he discovered he had more business than he could handle and decided to increase his price to $25k. No one cancelled and the demand for his services remained unaltered. It can be concluded that

I. between the prices of $20k and $25k the demand curve for the surgeon’s services is price inelastic

II. total revenue on all points on the demand curve for the surgeon’s services is constant

Which of the following is correct?

A. I only

B. II only

C. Both I and II

D. Neither I nor II

The correct answer is A. Price elasticity of demand equals ∆Q∆Q∆P∆P. On the demand curve for the surgeon’s services the quantity demanded remains unaltered when the price is increased from $20k to $25k. Thus ∆Q Q, the demand curve is price inelastic. Thus I is true. Total revenue equals price (P) × quantity (Q) with Q constant at all prices between $25k and $20k P × Q must increase as price increases from $20k to $25k. Thus II is wrong.

23

In an attempt to increase revenue the Secretary of the University has recommended that student fees be increased. The President of the student body has argued that the University, if it wishes to increase revenue, should decrease, rather than increase, student fees. It can be inferred from the opinions of the Secretary and President that they

I. disagree about whether the demand curve for the University’s education is responsive to prices (fees)

II. disagree about the price (fee) elasticity of the demand curve for the University places Which of the following is correct?

A. I only

B. II only

C. Both I and II

D. Neither I nor II

The correct answer is B. If fees were increased and revenues rose (cet par) the demand curve for the University’s education would be price inelastic and if revenues fell would be price elastic. Thus II is true. There is no evidence in this statement however to suggest that the demand curve for university places is not normally shaped, i.e. smaller number of places demanded the higher the fees; what they disagree about is the price elasticity of demand. Thus I is wrong.

24

The data below were collected in a London survey which was commissioned by retailers anxious to discover how demand was likely to change for their products in light of the significant increases in earned income caused by the sustained boom.

Which of the following identifies correctly the values for income elasticity for DH, FC, MU and WW taken in order?

Which of the following identifies correctly the values for income elasticity for DH, FC, MU and WW taken in order?

{table}

A. > 1, < 0, < 1, 0
B. < 1, > 1, 0, > 1
C. > 1, < 0, 0, 1
D. <1, 0, > 1, 0

The correct answer is C. For DH, the quantity demanded increases by a greater proportion (17%) than the increase in income (10%), therefore income elasticity of DH is > 1; for FC it is negative −4%/10%, for MU it is zero 0%/10% and for WW = 1, 10%/10%.

25

The driving forces of a market economy are

I. consumers attempting to maximise utility
II. firms attempting to maximise profit
III. government taxing households and firms to provide specified goods

Which of the following is correct?
A. I only
B. II only
C. I and II only
D. I, II and III only

The correct answer is C. This is a definitional question. I and II are true. A government sector is required in a market economy for a variety of reasons but it is not a driving force. Thus III is wrong.

26

A household allocates its budget on three goods, X, Y and Z, the price per unit of each being $2.00, $4.00 and $8.00 respectively. If the household is maximising satisfaction from the way it allocates its budget among X, Y and Z it follows that the satisfaction from the last unit of

I. Y consumed is ½ of the satisfaction from the last unit of X consumed

II. Y consumed is twice the satisfaction from the last unit of Z consumed

Which of the following is correct?

A. I only
B. II only
C. Both I and II
D. Neither I nor II

The correct answer is D. The condition of utility maximisation from a household allocating its budget among three goods X, Y and Z is that

27

A household is in equilibrium consuming only goods, x and y, i.e. maximising utility subject to a budget constraint. The price of good x falls and simultaneously the budget is increased. Assuming the household continues to consume only x and y what will happen to their purchases?

A. The quantity of x purchased will increase, the quantity of y purchased may increase, remain constant or decrease
B. The quantity of x purchased will increase, the quantity of y purchased will increase
C. The quantity of y purchased will decrease, the quantity of x purchased may increase, remain constant or decrease
D. The quantity of y purchased may increase remain constant or decrease, the quantity of x purchased may increase, remain constant or decrease.

 

The correct answer is A. Consider first the impact of price decrease in x in isolation. To re-establish equilibrium, i.e. equate MUaPa and MUbPb necessitates an increase in the quantity of x consumed and decrease in the quantity of y consumed. The effect of the budget increase, taken in isolation, will be to increase purchases of both x and y. Taking together the price and budget changes, the purchases of x will increase but net purchases of y will depend upon the relative strengths of the price effect and budget effect; i.e. they could increase, remain constant or decrease.

28

What is meant by the statement ‘The substitution effect is always negative’?

A. Less of some goods is purchased as incomes rise
B. Increases in the price of a good always lead to the substitution of relatively less expensive goods
C. At the price of zero on a linear demand curve price elasticity of demand is zero
D. If households start purchasing inferior goods their changes in income must have been negative

The correct answer is B. This is a definitional question. While statements A, C and D may be true, none of them describes the substitution effect. Consider a household in equilibrium concerning two goods a and b; i.e.

MUaPa = MUbPb 

If the price of A increases:

MUaPa will be <  MUbPb 

To re-establish utility maximisation some expenditure should be switched from a to b. How much? Until equality rules. The increase in the price of a leads to the substitution, at the margin, of the relatively cheaper b.

29

A household allocates daily income of $100 on a selection of goods and services.
In scenario 1 daily income increases by 10%; prices of goods and services remain constant.

In scenario 2 daily income remains constant; prices of goods and services decrease by 10%.

Comparing scenarios 1 and 2 which of the following is correct?

A. The household would be better off in scenario 1
B. The household would be better off in scenario 2
C. The household would be indifferent between scenarios 1 and 2
D. There is insufficient information to tell in which scenario the household would be better off

The correct answer is B. The household’s real income can increase in two ways; daily income can increase and prices of goods and services can remain constant, or daily income can remain constant and prices of goods and services can decrease. Suppose the household were initially allocating its $100 to the purchase of melons @ $1.00 each. The household buys 100 melons. When the daily income increases by 10% the household can now buy 110 melons. Suppose however the price of melons decreases by 10% each melon will now cost 90p. With an income of $100 the household can purchase 111 melons ($100/.90) i.e. almost 1% better off.

30

The differences between an individual demand curve and a market demand curve for a good are

I. the dependent and independent variables are reversed
II. the former is price inelastic, the latter price elastic

Which of the following is correct?
A. I only
B. II only
C. Both I and II
D. Neither I nor II

The correct answer is D. The conditions which hold for an individual demand curve hold for the market demand curve. Price is the independent variable, quantity demanded the dependent variable with relevant parameters determining the position of both curves. Thus I is wrong. A linear demand curve, be it individual or market, which touches both axes, price and quantity, will each have price elasticities varying from α to 0. Thus II is wrong.

31

Which of the following is the formula for price elasticity of demand?

A.  ∆Q∆P
B.  ∆QQ∆P
C.  ∆QQ∆PP
D.  QP

The correct answer is C. This is a definitional question. The price elasticity of demand is, for small changes in price, the relative change in quantity divided by the relative change in price.

32

In the demand curve above
I. P4 × 3 = P3 × 4
II. P2 × 6 = P1 × 12

Which of the following is correct?
A. I only
B. II only
C. Both I and II
D. Neither I nor II

The correct answer is C. In a curve of unitary price elasticity total expenditure on a good is constant at each and every price, i.e. P × Q is constant. Thus P1 × 12 = P2 × 6 = P3 × 4 = P4 × 3. Thus both I and II are true.

33

In the demand curve above

I. at point P112, the price elasticity of demand is zero
II. at point P43 the price elasticity of demand is infinite

Which of the following is correct?
A. I only
B. II only
C. Both I and II
D. Neither I nor II

The correct answer is D. In a demand curve of unitary elasticity, by definition, any point on the curve ∆QQ∆PP is constant and any given proportionate change in price is matched by an equal proportionate change in quantity demanded. In linear demand curves price elasticity of demand is zero where the demand curve meets the quantity axis and infinity where the demand curve meets the price axis. Thus both I and II are wrong.

34

It is a well known fact that cigarette smoking has a higher incidence in low income households than in high income households. It is also a well known fact that despite the ‘high’ price of cigarettes the demand is price inelastic.  It can be deduced from the above statements that reducing taxes on cigarettes would

I. increase the real income of the ‘poor’ relative to the ‘rich’

II. accepting the principle of consumer sovereignty, make the poor better off

III. increase sales of cigarettes with the proportional increase in the quantity demanded being greater that the proportional decrease in price

Which of the following is correct?

A. I only
B. I and II only
C. III only
D. I, II and III

The correct answer is B. Since the ‘poor’ smoke more than the ‘rich’ a higher proportion of their income will be allocated to tobacco purchases. A reduction in the price of cigarettes therefore will leave a large proportion of their incomes, compared to incomes of the rich, available for other goods and services. Thus not only will the real income of the poor increase relatively but all poor smokers will be better off and thus the poor as a whole will be better off. Thus I and II are true. The demand for cigarettes being price inelastic means that ∆QQ < ∆PP – the definition of price inelasticity. Thus III is wrong.