Chapter 2

Fundamental Economic Concepts

Solutions to Exercises

1. Equation [2.1] is the demand function: QD = f( P, PS, PC, Y, A, AC, N, CP, PE, TA, T/S, …). If the quantity demanded is the Toyota Prius, the P is the price of the car and as the price rises we would expect a decline in the quantity sold; PS is the price of substitutes and as the price of the Chevy Malibu rises we would expect the quantity of the Priuses to rise; PC is the price of complements and we would expect that as the price of things like replacement batteries rises we would see a decline in the quantity of Priuses sold; Y is income and we’d expect as income rises to sell more Priuses as they are normal goods; A is advertising and we’d also expect more Priuses sold as advertising and promotional expenditures rises; AC is competitors’ advertising and we’d expect a negative impact on the quantity of the Prius sold as AC rises; N is the size of the target market or population and we’d expect that larger markets will sell more Priuses; CP is consumer preferences for greener transportation which should help the Prius seen as being greener; PE is the expected future price of hybrid cars and we’d expect that the greater the resale price of the car that more will wish to buy it; TA is the purchase adjustment time period that tends to show that more Priuses are sold if the time period permitted for analysis is longer; and T/S involves taxes on or subsidies for hybrid cars that we say in periods when there are tax subsidies to buy hybrids that car sales of hybrids rises. Equation [2.2] is the supply function: QS = f(P, PI, PUI, T, EE, F, RC, PE, T/S, …). P is price, PI is inputs like metal, PUI is the price of unused inputs like fiberglass, T is technological improvement like robots; EE is exit or entry of other automakers, RC is the regulatory cost of compliance, PE