Finance/Econ

ECON E-1010

Spring, 2011

Problem Set 1

(Due Wednesday, Feb. 2)

1. How do each of the following events affect the market for frozen yogurt in the U.S.? For each event, show on a graph which curve has shifted and the resulting change in equilibrium price and quantity.

a. The price of ice cream falls.

a) Since the price of a substitute has fallen, the demand for the frozen yogurt must fall, so the demand curve must shift to the left thus lowering the equilibrium price and the quantity.

P

S

P1 E1

P2 E2

D1

D2

0 Q

b. The economy goes into recession, lowering many consumers’ incomes. (Note: State any assumptions you are making about frozen yogurt.)

b) It is safe to assume that frozen yogurt is a normal good. If we do this then lower incomes causes the demand to decrease, therefore shifting the demand curve to the left. The equilibrium price and the quantity decreases. (graph remains: the same above).

However, if the frozen yogurt is an inferior good, then lower income will cause the demand to increase moving the demand curve to shift to the right. (graph below)

P

S

P2 E2

P1 E1

D2

D1

0...