Problem Set 3

Data for the market for graham crackers is shown below.

Calculate the elasticity of demand between the following prices.

$1.00 - $1.50: ___________________________________

$1.50 - $2.00: ___________________________________

$2.00 - $2.50: ___________________________________

$2.50 - $3.00: ___________________________________

If the price of graham crackers is $2.50 should firms raise or lower their prices if they want to increase revenue?

Explain this in terms of elasticity.

1. Assume the competitive market shown below faces a short run price of $10. Using the graph below, identify the following: 

Profit maximizing output:       _______________________

Approximate mark up over cost _______________________

In the long run, the price falls to $7.50.

Why does this happen?

What is the new profit maximizing output? _______________________

1. A local hardware store is trying to decide whether to stay open. They have found that their industry is extremely competitive and profits have shrunk considerably.

Knowing that you have taken an economics course the owners have asked for your opinion. Draw a completely labeled graph to help you explain the shutdown decision.

You should show two graphs in your answer, one for the market as a whole, and one for this store in particular.

Assume that the store is losing money; however, explain why they may want to stay open for a little while longer. (NOTE: Your answer should be a written explanation of your graph.)

2. What combination of the two goods below allows you to maximize your utility with a budget constraint of $14?

Show how you arrived at your conclusion in the space provided below.

Place your final answers on the lines at the bottom of this page.

 PRICE = $0.50 per bottle

PRICE = $2.00 per bale

Bottles of glue: _________________________

Bales of hay: ____________________________