I. Multiple choice.

1. With an increase in income, a household actually wants to consume more of that commodity. Such product is called an inferior good (T/F).

2. Income elasticity can be either positive or negative depending on an item we are considering.

a) Income elasticity measures the responsiveness of demand to a price change in a related commodity.

b) Income elasticity measures the responsiveness of the demand to an income change.

c) Income elasticity measures the responsiveness of the elasticity to an income change.

II. Problems.

1. Suppose that demand and supply for textbooks can be described by the following equations:

QS = 150 + 2P

QD = 510 – P

where P is the price in dollars and Q is the quantity in units.

a) Determine algebraically the equilibrium price and quantity.

b) Suppose that the price were to be fixed at $110. Determine algebraically the surplus or shortage that would result.

2. Discuss the differences between elasticity of supply and elasticity of demand answering the following questions:

a) If the elasticity of demand in its absolute value is close to 2.5, is this market elastic or inelastic?

b) If the elasticity of supply in its absolute value is close to .95, is this market elastic or inelastic for suppliers?

c) If the value of elasticity is close to -1.25, do we speak about supply or demand, and how elastic is the market from your point of view (elastic vs. inelastic)?

3. How the value of total revenue is related to the value of elasticity? Why and how we can use the total revenue test for elasticity? How elasticity values can be applied by authority of the city/ state in order to make correct decisions in regards to taxation policy for consumer items?