Homework 2
Economics 503
Foundations of Economic Analysis
Assigned: Session 4;
Due: Session 6
1. On page 95 of the textbook, you find some estimated own-price elasticities of
demand for a variety of goods. Assume that the price of each of these goods goes
up by 1%. Estimate the change in total revenues generated in each of these
markets by the price changes.
a. Restaurant Meals – Elasticity of Demand: 1.61
b. Automobilies – Elasticity of Demand 1.07
c. Furniture – Elasticity of Demand 0.53
d. Food - .14
% Revenue % P  %Q

 1  elasticity D
%P
%P
a. Restaurant Meals – Elasticity of Demand: -.61
b. Automobilies – Elasticity of Demand -.07
c. Furniture – Elasticity of Demand .47
d. Food - .6
2. The accompanying table shows the average daily quantity of postcards sold to
tourists at the airport during each half of 2006 and 2007. Originally, the postcards
sold at HK$4 each. However, they were raised to $5 on July 1st, 2006 then raised
to $6 on July 1st 2007. The Airport Authority assumes that the average income of
an airport traveler in 2006 was HK$200,000. They estimate the average income
was HK$300,000 in 2007. Assuming that no other factors affecting the demand
for postcards changed (i.e. ceteris parabis) calculate the price elasticity of
demand as prices changes from $4 to $5 and the price elasticity as prices change
from $5 to $6. In both cases, use the mid point method. Calculate the income
elasticity of postcards using the midpoint method.
2006
2007
P = 4 4000
P = 5 3000
4000
P=6
3500
(Q0  Q1 )
(Q0  Q1 )
Own price elasticity of demand
( P1  P0 )
( P0  P1 )
(4000  3000)
When P0 = 4.
(5  4)
(4000  3000)
(5  4)

1000
1
7000  7  9  1.286
7
1
1
9
9
(4000  3500)
When P0 = 5.
(6  5)
(4000  3500)
Income1  Income0
(4000  3000)
(300000  200000)
500
(5  6)
Q1D  Q0D
Income Elasticity

1
7500  15  11  0.7333
15
1
1
11
11
Q1D  Q0D
when Income0 is 200,000
Income1  Income0
(4000  3000)

(300000  200000)
1000
100000
7000
1
 7  5  0.714
7
1
5
500000
3. The following is a demand table for oil as well as a supply table. Calculate the
equilibrium price in a range of $10. Assume the cross-price elasticity of demand
of oil with respect to the price of coal is 1.5. Is coal a substitute or a complement
to oil. Assume that the price of coal increases by 10%. Calculate the new demand
schedule for coal (you do not need to use the midpoint method) Calculate the new
equilibrium.
P
Quantity Supplied Quantity Demanded
60
80,059.86
83,033.06
70
81,303.55
81,762.92
80
82,396.49
80,678.38
90
83,372.72
79,733.70
100
84,255.78
78,898.04
110
85,062.66
78,149.63
120
85,806.03
77,472.59
130
86,495.60
76,854.95
140
87,138.99
76,287.50
150
87,742.26
75,762.98
The equilibrium is between 70 and 80 dollars per barrel. The increase in the price of coal
shifts the demand for oil out by 15%. This means that coal and oil are substitutes.
Multiply the demand curve at every price level by 1.15. At the new demand curve, if the
price is 140, there is excess demand; if the price is 150, there is excess supply. This
means that the price goes to a new equilibrium
P
Quantity Supplied
Quantity Demanded
Quantity Demanded'
60
80,059.86
83,033.06
70
81,303.55
81,762.92
80
82,396.49
80,678.38
90
83,372.72
79,733.70
100
84,255.78
78,898.04
110
85,062.66
78,149.63
120
85,806.03
77,472.59
130
86,495.60
76,854.95
140
87,138.99
76,287.50
95488.02456
94027.35724
92780.14249
91693.76024
90732.74161
89872.07425
89093.47721
88383.19533
87730.62641
150
87,742.26
75,762.98
87127.43083
4. Estimate the current real interest rate in Hong Kong. There are two steps: 1) get
the nominal interest rate; and 2) estimate the future inflation rate.
a. To measure current interest rates, i, Use the end of period 12 Month
HIBOR (Hong Kong Interbank Offered Rate) rate from December, 2010
found in Table 6.3.1 of the Hong Kong Monetary Authorities Monthly
Statistical Bulletin. This can be found at this webpage
http://www.info.gov.hk/hkma/eng/statistics/msb/index.htm
.8% or i = .008.
b. To estimate the future inflation rate, πt+1, use the year-on-year % growth of
the Composite Consumer Price Index for November, 2010 from Table 052
in Hong Kong Statistics from Bureau of Census and Statistics. This can be
found on this webpage
http://www.censtatd.gov.hk/hong_kong_statistics/statistics_by_subject/ind
ex.jsp?subjectID=12&charsetID=1&displayMode=T
2.9% or the estimate of inflation is πt+1 = .029. The estimate of the ex ante
interest rate is r = i- πt+1 =.008- .029=-.021. The real interest rate in
Hong Kong is estimated at -2.1%.
5. For the country of Elbonia, there is a saving curve which shows the relationship
between national supply of loanable funds from the private sector at any real
interest rate: S = 300*r . The private sector level of demand for loanable funds is
also a function of the interest rate, D = 20-100*r.
a. Assume government savings is 0. Assume Elbonia’s loanable funds
market is closed so supply and demand for loanable funds are equal. Solve
for the equilibrium real interest rate and quantity in the loanable funds
market.
Supply and demand are equal so S = 300*r = 20-100*r = D.
20
300r  20  100r  400r  20  r 
 .05 so S = 300r = 15.
400
b. Assume that Elbonia is part of a global capital market and the world real
interest rate is rW = .06. Calculate Elbonian supply of loanable funds,
demand for loanable funds and capital inflows.
S = 300*.06 = 18.; D = 20-100*.06 = 14. So KA =-4.
c. The Elbonian government runs a deficit and has government savings of 20. Calculate, supply and demand of Elbonian loanable funds at an interest
rate of rW = .06. What are capital inflows.
Now, D = 20-100r+20 = 40-100r = 34, so KA = 16.