Question

1. Assume goods X and Y are substitutes. An increase in the price of X would cause the demand for Y to increase.

True

False

2. Assume that in an effort to help consumers, the government decides to reduce the amount of taxes it imposes on sellers of gasoline, that is, sellers are required to pay the government a smaller fee for each gallon of gas they sell. In the market for gas, this would have the effect of causing an increase in the supply of gas and a decrease in equilibrium price.

True

False

3. Assume that when the price of good X is $7, the quantity demanded is 25. When the price is increased to $9, the quantity demanded falls to 20. Based on this information, over the range in question demand is elastic.

True

False

4. Assume the firms in a perfectly competitive market are initially incurring economic losses. An increase in supply would cause existing firms' economic losses to decrease.

True

False

5. Assume the market shares of the six largest firms in an industry are 15 percent each. The six-firm concentration ratio would indicate that the industry is highly concentrated, while the Herfindahl- Hirschman Index would not.

True

False

Answer 1

1) Good X and Y are substitutes. An increase in price of X will induce consumers to demand of Y because they wants to minimize their cost of consuming goods. This statement is true.

2) As demand of gasoline is inelastic, decrease in tax on gasoline will benefit more consumers than producers which will raise demand more than rise in supply. It will result in price rise due to rise in aggregate demand more than price fall due to rise in aggregate supply. Thus, price will rise which make this statement false.

3) Elasticity of demand = %change in quantity demanded / %change in price

%change in quantity demanded = [(20 - 25) / 25] * 100 = -20%

%change in price = [(9 - 7) / 7] * 100 = 28.57%

Elasticity of demand = -20% / 28.57% = -0.7

We can ignore the negative sign because of negative relationship between price and quantity demanded. Elasticity of demand less than 1 says that demand is inelastic in this range.

4) Firms are incurring losses in perfectly competitive market. An increase in supply happens due to rise in number of firms in the market which reduce the sales of each producer and raise everyone losses. This statement is false.

5) Six firm concentration ratio = [(6 * 155) / 100%] = 90%. It says that market is highly concentrated.

HHI is the sum of square of market share of all firms = 6 * 15^² + 10^² = 1,450. It says that market is less moderately concentrated.

This this statement is true.