ECON 310-1: Microeconomic Theory

Professors James A. Hornsten and Ronald R. Braeutigam

Northwestern University, Winter 2016

Problem Set #1: Comparative Statics, S&D Analysis, and Elasticity

Instructions: This problem set will not be collected, but we encourage you to work on the problems, both
individually and with a group. During the upcoming weeks discussion sections, the teaching assistants will
go over some of the solutions and present similar problems from old exams.
1. Consider the example of the comparative statics problem with an equilibrium discussed in class.
The supply curve PS = 2Qw, where PS is the price on the supply curve at a quantity of Q, and w is the wage
rate producers must pay. The demand curve is Pd = 210 Q, where Pd is the price on the demand curve at
a quantity of Q. Find the comparative statics derivatives that show how a small change in the exogenous
wage rate affects the two endogenous variables, the equilibrium quantity and the equilibrium price.
dQ
dP
In other words, find
.
and
dw
dw
2. The demand for shoes in a market is Q d = (100 2P) Y , where Y is the level of income, P the price,
S
and Qd is the
quantity demanded. The market supply curve is described by Q = 5P .
a) On a graph show the demand curve for each of the following levels of income:
Y = 100, Y = 400. How does the choke price change as the level of income varies?
b) Show that the demand curve has a constant income elasticity of demand, and find the numerical
value of that elasticity. In words summarize what this tells us about the impact on the quantity that
would be demanded when the level of income in the market rises by 1%.

3. Continue using the supply and demand curves from the previous problem about the market for shoes.
Lets examine the effects on the equilibrium price as income changes from 100 to 400.
a) If the level of income is 100, find the equilibrium price and show the equilibrium in the graph you
have drawn in part (a).
b) What is the value of the own price elasticity of demand at the equilibrium price you found in part
(a)? What does this value tell us?
c) If the level of income is 400, find the equilibrium price and show the equilibrium in the graph you
have drawn in part (a).
4. Using the supply and demand curves from the previous two problems, lets now examine how the
equilibrium price will change for any level of income.
a) Find the reduced form relationship that shows how the equilibrium price depends on the level of
income.
b) Verify that the reduced form predicts the same equilibrium prices you found in in question 2 for
Y=100 and Y=400.
c) Use the reduced form to infer how the equilibrium price will change as the level of the income
continues to rise. Will the price always rise when income increases?
5. Do Problem 2.17 in B&Bs 4th or 5th edition. Because it is very early in the quarter and you may have not
obtained the textbook, here is the problem: Consider the following demand and supply relationship in the
market for golf balls: Qd = 90 2P 2T and QS = 9 + 5P 2.5R, where T is the price of titanium, a metal
used to make golf clubs, and R is the price of rubber.
a) If R = 2 and T = 10, calculate the equilibrium price and quantity of golf balls.
b) At the equilibrium values, calculate the price elasticity of demand and the price elasticity of
supply.
c) At the equilibrium values, calculate the cross-price elasticity of demand for golf balls with respect
to the price of titanium. What does the sign of this elasticity tell you about whether golf balls and
titanium are substitutes or complements?

Profs James A. Hornsten & Ronald R. Braeutigam

ECON 310-1: Microeconomic Theory
Northwestern University Winter 2016

Problem Set #1 SOLUTIONS

Comparative Statics, S&D Analysis, Elasticity
Discussed in Sections in Week 2

Instructions: This problem set need not be handed in. The teaching assistants will go over it in sections.
1. Consider the example of the comparative statics problem with an equilibrium discussed in class.
The supply curve PS = 2Qw, where PS is the price on the supply curve at a quantity of Q, and w is the wage
rate producers must pay. The demand curve is Pd = 210 Q, where Pd is the price on the demand curve at
a quantity of Q.
Find the comparative statics derivatives that show how a small change in the exogenous wage rate affects
the two endogenous variables, the equilibrium quantity and the equilibrium price.
dQ
dP
In other words, find
.
and
dw
dw
Answer to 1.
If Supply given by P S = 2Qw and Demand given by P d = 210 Q, then in equilibrium

we require P S = P d . Thus, 2Qw = 210 Q.

To find the comparative statics effect of a change in the wage rate on the equilbrium quantity,
we need to find the reduced form equation that tells us how Q depends on the exogenous variable w.
Solving for the endogenous variable Q as a function of exogenous variable w, we find
210
dQ
420
we find that Q =
. Thus
=
. This tells us how much the equilibrium
2w + 1
dw
(2w + 1) 2
quantity will fall as the wage rate rises by a little. Note that the derivative is not a constant because
it depends on w.

To find the comparative statics effect of a change in the wage rate on the equilibrium price,
we need to find the reduced form equation that tells us how P depends on the exogenous variable w.
Since the price equilbrium price P is the same as P S and P d , we substitute the equilibrium quantity
210
Q=
(as determined above) into either the structural supply equation P S = 2Qw
2w + 1
420w
or the structural demand equation P d = 210 Q. Either way we find that P =
.
2w + 1
dP
420
Thus
=
. This tells us how much the equilibrium price will rise as the wage rate
dw (2w + 1) 2
rises by a little. Note that the derivative is not a constant because it depends on w.
Final comment : Note that the effects of a small change of w on P and Q have the same magnitude,
but opposite signs. This is because the demand curve has a slope of - 1. When w rises,
Q goes down by a certain amount, and P thus goes up by the same amount.

2. The demand for shoes in a market is Q d = (100 2P) Y , where Y is the level of income, P the price,
and Qd is the quantity demanded. The market supply curve is described by Q S = 5P .
c)

On a graph show the demand curve for each of the following levels of income:
Y = 100, Y = 400. How does the choke price change as the level of income varies?
d) Show that the demand curve has a constant income elasticity of demand, and find the numerical
value of that elasticity. In words summarize what this tells us about the impact on the quantity that
would be demanded when the level of income in the market rises by 1%.

Answer to 2.
a)

P
50
44.44
40

S
D when Y = 100
D when Y = 400

200

1000

2000

222.2

When Y = 100, the horizontal intercept is Q d = [100 2(0)] 100 = 1000

When Y = 400, the horizontal intercept is Q d = [100 2(0)] 400 = 2000 .
The choke price will be the price at which the quantity demanded becomes zero. Setting Qd=0 for the
demand curve, then at the choke price 0 = (100 2P) Y . When income is positive, the choke price (the
vertical intercept of the demand curve) is always 50. In other words, the choke price is the same for all
levels of positive income.
b) The income elasticity of demand at any price and income is EQ.Y =
The derivative of Q with respect to Y is:

dQ Y
.
dY Q

dQ 100 2P
=
.
dY
2 Y

Y
dQ Y 100 2P
(
) = 0.5 . So the income elasticity of demand is a constant
=
dY Q
2 Y
(100 2P) Y
(0.5), for all levels of P and Y.
Interpretation: Given any price, when income rises by 1%, the quantity demanded increases by 0.5%.
Thus EQ.Y =

3. Continue using the supply and demand curves from the previous problem about the market for shoes.
Lets examine the effects on the equilibrium price as income changes from 100 to 400.
d) If the level of income is 100, find the equilibrium price and show the equilibrium in the graph you
have drawn in part (a).
e) What is the value of the own price elasticity of demand at the equilibrium price you found in part
(a)? What does this value tell us?
f) If the level of income is 400, find the equilibrium price and show the equilibrium in the graph you
have drawn in part (a).
Answer to 3.
a) In equilibrium, QS=Qd. When Y=100, 5P = (100 2P) 100 .
Thus, 5P=1000 20P, which tells us that the equilibrium price is P=40.

Using the supply curve, we find the equilibrium quantity by Q*=5P =5(40) = 200.
b) EQ.P =

dQ P
dP Q

The derivative of Q with respect to P is:

dQ
= 2 Y . Therefore,
dP

dQ P
P
40
= (2 Y ) = (2 100 )
= 4
dP Q
Q
200
Interpretation: Moving along the demand curve, an increase in price of 1% will lead to a decrease in
quantity of about 4%.
EQ.P =

c) In equilibrium, QS=Qd. When Y=400, 5P = (100 2P) 400 .

Thus, 5P=2000 40P, which tells us that the equilibrium price is P=44.44.
Using the supply curve, we find the equilibrium quantity by Q*=5P =5(44.44) = 222.2.

4. Using the supply and demand curves from the previous two problems, lets now examine how the
equilibrium price will change for any level of income.
d) Find the reduced form relationship that shows how the equilibrium price depends on the level of
income.
e) Verify that the reduced form predicts the same equilibrium prices you found in in question 2 for
Y=100 and Y=400.
f) Use the reduced form to infer how the equilibrium price will change as the level of the income
continues to rise. Will the price always rise when income increases?

Answer to 4.
a) To find the reduced form, use the equilibrium condition QS=Qd. 5P = (100 2P) Y
Solving this to see how the endogenous variable P depends on the exogenous variable Y, we find that
100 Y
P=
.
5+ 2 Y
b) When Y = 100 (as in 2(a)), we see that P =
When Y = 400 (as in 2(c)), we see that P =

100 100 1000

=
= 40 , the same as in 2(a).
25
5 + 2 100

100 400 2000

=
= 44.44 , the same as in 2(c).
45
5 + 2 400

c) One way to see how the equilibrium price changes as income rises is to divide the numerator and
denominator of the reduced form by Y .

100 Y
100
=
.
5
5+ 2 Y
+2
Y
As Y increases, the denominator decreases, and thus P always increases.
Note: Asymptotically the price approaches the choke price of 50 as income becomes very large.
P=

5. Do Problem 2.17 in B&Bs 4th or 5th edition. Because it is very early in the quarter and you may have not
obtained the textbook, here is the problem: Consider the following demand and supply relationship in the
market for golf balls: Qd = 90 2P 2T and QS = 9 + 5P 2.5R, where T is the price of titanium, a metal
used to make golf clubs, and R is the price of rubber.
d) If R = 2 and T = 10, calculate the equilibrium price and quantity of golf balls.
e) At the equilibrium values, calculate the price elasticity of demand and the price elasticity of
supply.
f) At the equilibrium values, calculate the cross-price elasticity of demand for golf balls with respect
to the price of titanium. What does the sign of this elasticity tell you about whether golf balls and
titanium are substitutes or complements?
Answer to 5.
a) Substituting the values of R and T, we get Demand: Qd = 70 2P, and Supply: QS = 14 + 5P. In
equilibrium, 70 2P = 14 + 5P, which implies that P = 12. Substituting this value back, Q = 46.
b) PED = 2(12/46), or 0.52. Price-Elasticity of Supply = 5(12/46) = 1.30.
c) CPEDgolf,titanium = (-2)(10/46) = 0.43. The negative sign indicates that titanium and golf balls are
complements, i.e., when the price of titanium goes up, the demand for golf balls decreases.