AP_Krugman_Textbook

Tackle the Test:

Multiple-Choice Questions

1. d


2. c


3. b


4. e


5. c
   Tackle the Test:
   Free-Response Questions


6. a.The substitution effect will decrease the quantity
   demanded. As price increases, consumers will buy other
   goods instead.
   b.The income effect will increase the quantity demanded.
   As price increases, real income decreases, so consumers
   will purchase more of the inferior good.
   c.The substitution effect is larger than the income effect. If
   the income effect were larger than the substitution effect,
   more of the good would be purchased as the price
   increased, and the demand curve would be upward sloping.

Module 47

Check Your Understanding

1. a.Elastic demand. Consumers are highly responsive to
   changes in price. For a rise in price, the quantity effect
   (which tends to reduce total revenue) outweighs the price
   effect (which tends to increase total revenue). Overall,
   this leads to a fall in total revenue.
   b.Unit-elastic demand. Here the revenue lost to the fall in
   price is exactly equal to the revenue gained from higher
   sales. The quantity effect exactly offsets the price effect.
   c.Inelastic demand. Consumers are relatively unresponsive
   to changes in price. For consumers to purchase a given
   percent more, the price must fall by an even greater per-
   cent. The price effect of a fall in price (which tends to
   reduce total revenue) outweighs the quantity effect
   (which tends to increase total revenue). As a result, total
   revenue decreases.
   d.Inelastic demand. Consumers are relatively unresponsive
   to price, so a given percent fall in output is accompanied
   by an even greater percent rise in price. The price effect of
   a rise in price (which tends to increase total revenue)
   outweighs the quantity effect (which tends to reduce total
   revenue). As a result, total revenue increases.


2. a.Once bitten by a venomous snake, the victim’s demand
   for an antidote is very likely to be perfectly inelastic
   because there is no substitute and it is necessary for sur-
   vival. The demand curve will be vertical at a quantity
   equal to the needed dose.
   b.Students’ demand for blue pencils is likely to be perfectly
   elastic because there are readily available substitutes, such
   as yellow pencils. The demand curve will be horizontal at
   a price equal to that of non-blue pencils.
   Tackle the Test:
   Multiple-Choice Questions


3. d


4. d

Module 46

Check Your Understanding

1. a.Since spending on orange juice is a small share of Clare’s
   spending, the income effect from a rise in the price of
   orange juice is insignificant. Only the substitution effect,
   represented by the substitution of lemonade for orange
   juice, is significant.
   b.Since rent is a large share of Delia’s expenditures, the
   increase in rent generates an income effect, making Delia
   feel poorer. Since housing is a normal good for Delia, the
   income and substitution effects move in the same direc-
   tion, leading her to reduce her consumption of housing
   by moving to a smaller apartment.
   c.Since a meal ticket is a significant share of the students’
   living costs, an increase in its price will generate an
   income effect. Students respond to the price increase by
   eating more often in the cafeteria. So the substitution
   effect (which would induce them to eat in the cafeteria
   less often as they substitute restaurant meals in place of
   meals at the cafeteria) and the income effect (which
   would induce them to eat in the cafeteria more often
   because they are poorer) move in opposite directions.
   This happens because cafeteria meals are an inferior
   good. In fact, since the income effect outweighs the sub-
   stitution effect (students eat in the cafeteria more as the
   price of meal tickets increases), cafeteria meals are a
   Giffen good.


2. By the midpoint method, the percent change in the price
   of strawberries is

× 100 = × 100 = −40%

Similarly, the percent change in the quantity of strawber-

ries demanded is

× 100 = × 100 = 67%

Dropping the minus sign, the price elasticity of demand

using the midpoint method is 67%/40% =1.7.

3. By the midpoint method, the percent change in the
   quantity of movie tickets demanded in going from 4,000
   tickets to 5,000 tickets is

× 100 = × 100 = 22%

Since the price elasticity of demand is 1 at the current

consumption level, it will take a 22% reduction in the

price of movie tickets to generate a 22% increase in

quantity demanded.

4. Since price rises, we know that quantity demanded must
   fall. Given the current price of $0.50, a $0.05 increase in
   price represents a 10% change, using the method in
   Equation 46-2. So the price elasticity of demand is

= 1.2

so that the percent change in quantity demanded is 12%.

A 12% decrease in quantity demanded represents 100,000

×0.12, or 12,000 sandwiches.

% change in quantity demanded

10%

1,000

4,500

5,000−4,000

(4,000+ 5,000)/2

100,000

150,000

200,000−100,000

(100,000 + 200,000)/2

−$0.50

$1.25

$1.00 −$1.50

($1.50 +$1.00)/2

S-28 SOLUTIONS TO AP REVIEW QUESTIONS