File

Economics 101

Fall 2014

Answers to Homework #3

Due 10/30/14

Directions: The homework will be collected in a box before the lecture. Please place your name, TA name and section number on top of the homework. Write legibly throughout the whole homework. Make sure you write your name as it appears on your ID so that you can receive the correct grade. Please remember the section number for the section for which you are registered, because you will need that number when you submit exams and homework. Late homework will not be accepted so make plans ahead of time to insure that your homework is submitted. Good luck!

Your homework reflects you: please make sure that you submit a neat, organized, and legible set of answers!

Remember to show all your work. Also remember that calculators are not permitted on the exam, so you should try these manually.

Part I: Excise Tax

1. Consider the ice cream market in Madison. In July, the ice cream market demand and supply curves are given by the following equations where Q is the quantity to ice cream units and P is the price in dollars per unit of ice cream:

Demand: Q = 14000 – 10P

Supply: Q = 2000 + 20P

a) Find the equilibrium price and quantity of ice cream in July.

In equilibrium, we know that the quantity demanded = quantity supplied. Thus, by solving the two equations, we have the equilibrium price = $400 per unit of ice cream and the equilibrium quantity = 10,000 units of ice cream.

b) Calculate the price elasticity of demand and supply at the equilibrium price in July. Use the point elasticity formula to compute these two values of these elasticities.

Answer:

The point elasticity of demand formula is

Elasticity of Demand = (-1/slope)(P/Qd)

and the point elasticity of supply formula is

Elasticity of Supply = (1/slope)(P/Qs)

At the equilibrium quantity and price we know (Q, P) = (10000, 400). We also have the demand and supply equations, but they are not in slope-intercept form. So, rewriting the two equations in...