Question

1. Scarcity forces society to confront three critical issues. List those issues and explain how they are related to the problem of scarcity.   

2. Suppose that the quantity demanded and quantity supplied in the market for milk is as follows:

Price per Gallon	Quantity Demanded	Quantity Supplied
$5	1,000	5,000
$4	2,000	4,500
$3	3,500	3,500
$2	4,100	2,000
$1	6,000	1,000

1. What is the equilibrium price and quantity of milk?
2. If the government places a price ceiling of $2 on milk, will there be a shortage or surplus of milk? How large will it be? How many gallons of milk will be sold?

3. If the percentage change in quantity demanded is greater than the percentage change in price, can you determine if the demand is elastic, unit elastic, or inelastic? Explain your answer

Answer 1

1.

The fundamental economic problem is the issue of scarcity but unlimited wants. Scarcity implies there is only a limited quantity of resources, e.g. finite fossil fuels. Because of scarcity, there is a constant opportunity cost – if you use resources to consume one good, you cannot consume another. Therefore, an underlying feature of economics is concerned with dealing with how to allocate resources in society to make the most efficient and fair use of resources.

The critical issues arising due to the scarcity problem are:

i) What goods and services to produce? - an economy must decide whether they should produce kitchen appliances or weapons, build and fix roads or buy textbooks for schools

ii) How to produce goods and services? - should we use copper or plastic to make pipes? Should machines be used to make clothing or should workers make it by hand? Should the power plant be built close to the ocean or inland? Which fertilizer is best for growing strawberries? There are millions of decisions that need to be made to figure out how to produce goods and services.

iii) For whom to produce? - Once the goods and services are produced, who will get to consume them? Will people consume them on a first-come, first-served basis? Should goods be allocated or given out by height, weight, religion, age, gender race, looks, strength, health, or wealth? How should the goods and services be distributed among the people?

2.

a.

The equilibrium would occur where Quantity demanded = Quantity supplied

This occurs at 3500 gallons of milk

The equilibrium price is $3

b.

When the government imposes $2 price ceiling, the quantity demanded is 4100 and the quantity supplied is 2000

Thus, since, the quantity supplied is less than quantity demanded, there exists a shortage of milk

The shortage = 4100 -2000 = 2100 gallons

Only 2000 gallons of milk would be sold.

3.

When the percentage change in quantity demanded is greater than the percentage change in price, the demand is elastic.

Price Elasticity of Demand=percent change in quantity/percent change in price

In the given example, the absolute percent change in quantity = abs(50-100)/100 = 50%

Absolute percent change in price = abs(60-50)/50 = 20%

Price Elasticity of Demand = 50%/20% = 2.5 (>1)

Hence, the demand is elastic