AP Macroeconomics Page 1 of 5 Assignment: Apply Tools of Market Analysis User Name: Clara
Bui (print clearly) Instructor: Young Kim Date: Nov 29th, 2023
1. A very important economic relaKonship is that between elasKcity and revenue.
A. Consider the market for gasoline. Because there are very few good subsKtutes for gasoline,
the demand for gasoline is probably inelasKc.
i. If the price of gasoline rises by 10%, by what percentage is the quanKty
demanded likely to fall? (4 points)
Less than 10%
ii. Suppose the price of gasoline rises by 10% and, as a result, the quanKty demanded
falls by 5%. Will consumer expenditures on gasoline rise or will they fall? (4 points)
Consumer expenditure will rise because the decrease in quanKty demanded
is smaller than the price increase
B. Now, consider demand for the gasoline sold by Gas StaKon G in a large city. The gasoline sold
by other staKons is an excellent subsKtute for the gasoline sold by StaKon G. Because there are
many good subsKtutes for gasoline, its demand is probably elasKc.
i. If the price at Gas StaKon G rises by 10%, by what percentage is its quanKty sold
likely to change, other things being the same? (4 points)
As price elasKcity of demand is the raKo of the percentage of a change in
quanKty demanded and the percentage of a change in price, price elasKcity must
be greater than 1 to be elasKc. The percentage change in quanKty demanded
must be greater than 10% and therefore, the quanKty sold must be greater than
10%
ii. In this case, what will happen to StaKon G's revenues when the price rises? (4 points)
When the price rises and demand is elasKc, percentage decrease in quanKty sold
will be larger than the percentage increase in price, leading to a decrease in
revenue
C. Make a general statement about how revenues will change when the price rises or when it
falls if demand is elasKc and if it is inelasKc. (4 points)
When demand is elasKc, an increase in price leads to a decrease in revenue, and a
decrease in price leads to an increase in revenue. Conversely, when demand is inelasKc, an
increase in price leads to an increase in revenue, and a decrease in price leads to a
decrease in revenue.
D. It is oZen suggested that increasing gasoline taxes will reduce the quanKty of gasoline people
will buy and, as a result, reduce air polluKon. In the short run would such a policy be effecKve in
reducing air polluKon? Would the policy be effecKve in reducing air polluKon in the long run?
Why? (6 points)
In the short run, increasing gasoline taxes may have a limited effect on reducing air polluKon,
parKcularly if the demand for gasoline is inelasKc. In the long run, the policy is likely to be more
effecKve as consumers adapt their behavior, especially if the demand becomes more elasKc
over Kme, leading to significant reducKons in air polluKon. The key lies in the elasKcity of
consumer response to price changes.
2. A^empts at controlling illegal drugs are usually targeted at suppliers. How effecKve is this
likely to be? Let’s think about it.
A. Assuming this iniKal statement is true, show the effect of increased enforcement
acKviKes on the market for illegal drugs. Use a demand and supply graph in your
explanaKon. What are the effects on the market price and quanKty? (2 points)
Increased enforcement acKviKes targeKng drug suppliers typically decrease the
supply of illegal drugs. On a demand and supply graph, this would shiZ the supply
curve to the leZ, leading to a higher equilibrium price and a lower quanKty traded.
However, the overall impact on reducing drug availability may be limited, as demand
oZen remains relaKvely constant. This approach might result in higher prices but not
necessarily a substanKal decrease in the overall quanKty of illegal drugs consumed.
B. Discuss why, in your opinion, the demand for illegal drugs might be elasKc or inelasKc.
(2 points)
I think the demand for illegal drugs is inelasKc, because drugs are highly addicKve
and there are limited subsKtutes.
C. ElasKcity of demand determines whether price increases result in more or less total
spending by buyers. Would the dealer find it profitable (consider costs) to elude law
enforcement if demand was elasKc? InelasKc? (2 points)
If the demand for illegal drugs is elasKc, the increase in price will decrease the
demand of the buyer. In this case, the dealer is less profitable to elude the law.
If the demand is inelasKc, the price increase would result in a small reducKon in the
buyer’s spending. In this case, the dealer is more profitable to elude the law.
3. The labor market is very important in macroeconomics. Although there are many different
types of labor, and different areas in which it’s offered, let’s assume that there is just one labor
market and one wage.
A. In good economic Kmes, demand for labor increases. Show in a supply and demand
diagram the effect of this increase on wages and the total quanKty of labor exchanged. (2
points)
B. Many countries have large numbers of immigrants each year. These immigrants have
typically moved to a new country to find work. Show in a supply and demand diagram the effect
of this immigraKon on wages and the total quanKty of labor exchanged. (2 points)
C. When economic condiKons turn bad, the demand for labor usually decreases.
However, many people are hesitant to take jobs for less than they made in the past, meaning
that wages don't easily fall. Use a supply and demand diagram to show the effect of this
phenomenon. Is the effect more similar to that of a price ceiling or of a price floor? (4 points)
Similarity to Price Floor: Just as a price floor sets a minimum price for a good or service, wage
rigidity acts as a barrier prevenKng wages from falling below a certain level. This makes the
effect more similar to that of a price floor
D. Explain how markets usually move toward equilibrium aZer a decrease in demand
and why, in the situaKon discussed in part C above, this equilibrium isn't achieved. (4 points)
In markets, prices usually adjust to balance supply and demand, but in the labor
market in part C, wages may not easily fall when demand for labor decreases due to
factors like workers’ reluctance to accept lower wages, which can cause imbalance
4. Another market that is very important in macroeconomics is the market for credit, oZen
referred to as a money market or loanable funds market. In this market, the buyers are people
who borrow money, and the sellers are people who lend money. The price of money, or the
price of using someone else’s money for some amount of Kme, is the interest rate. The interest
rate is the price in the market for credit.
A. Explain what a downward-sloping demand curve means in the context of the credit
market. (3 points)
In the credit market, a downward-sloping demand curve indicates that as the interest
rate decreases, the quanKty of credit demanded for borrowers increases. When
interest rates are lower, more people are willing to borrow money.
B. Explain what an upward-sloping supply curve means in the context of the credit
market. (3 points)
In the credit market, an upward-sloping supply curve means that as the interest rate
increases, the quanKty of credit supplied by lenders increases. When interest rates
rise, lenders are more inclined to provide loans because they can earn higher
returns.
C. Some governments limit the rate of in terest that may be charged on a loan. In these
places it may be illegal for a lender to charge a rate of interest above a certain level. Use a
supply and demand diagram to show the effect of these limits, assuming that the limit is below
the equilibrium interest rate. (5 points)
D. What will this do to the total quanKty of lending and borrowing done? (5 points)
A government-imposed interest rate ceiling below the equilibrium rate may lead to
credit shortages and potenKal credit raKoning. The overall quanKty of lending and borrowing
may be limited, creaKng inefficiencies in the credit market. The enKre quanKty will result in a
reducKon in the amount of lending and borrowing that takes place.
