Here are two statements about how people\'s expectations of future prices affect

Question

Here are two statements about how people's expectations of future prices affect what they do in the current period. I If both buyers and sellers expect the price to rise next period, the price would fall in the current period. II If buyers expect the price to rise next period and sellers expect the price to fall next period, the quantity traded would rise in the current period. Choose the correct option from the list below. A Neither statement is true. B Only I is tme. C Only II is true. D Both statements are true. QUESTIONS 14-23 test your understanding of elasticity and its applications. 14. The absolute value of the price elasticity of demand of a straight-line demand curve A is constant and equal to one. B varies over its length from infinity to zero (as price falls). C varies over its length from zero to infinity (as price falls). 15. Consider the case of a good for which the absolute value of the price elasticity of demand greater than one. A fall in the price would cause A total revenue to rise and marginal revenue would be greater than zero. B total revenue to fall and marginal revenue would be less than zero. 16. Consider the case of a good for which the absolute value of the price elasticity of demand less than one. A fall in the price would cause A total revenue to rise and marginal revenue would be greater than zero. B total revenue to fall and marginal revenue would be less than zero. 17. On Saturdays through Wednesdays Smoke Eaters offer "Happy Hour" between 9 PM an midnight. This suggests that the management believes that the demand for drinks is A less price elastic on Thursday and Friday evenings after 9 PM. B more price elastic on Thursday and Friday evenings after 9 PM. 18. The shorter the time period under consideration, A the less responsive is the quantity supplied of a good to a change in its price. B the more responsive is the quantity supplied of a good to a change in its price. 19. The larger the share of the market for inputs

Explanation / Answer

13. The expectation regarding the future price level acts differently for the buyers and sellers. For example, if the buyers expect the price to rise in the next period, then they would spend more of his income on the goods and services on this period; whereas if the sellers expect the price to go up in future, they would restrict the supply of the current period to some extent. So, that’s two quite different way of how the expectation shape the decision of buyers and sellers.

Now, let us analyze the statements given:

1. If both buyers and sellers expect the price to go up in next period, then for the buyers, they would be demanding more in the current period, which will create excess demand in the current period, which in turn would put pressure on the price to go up. And for the sellers, they would decrease the supply of goods as they would be expecting higher return for future. So, there will arise supply crunch in the market, which accompanied by the excess demand would put more pressure to go up as the seller would expect that the price will go up further in future.

Therefore statement 1 is not true.

2. Now, if the buyers expect the price to rise in the next period, then as explained earlier, there will arise excess demand in the market, which will raise the price in the current period. On the other hand, if the sellers expect the price to fall in the next period, then they would increase their supply at the current price. Now accompanying with the excess demand in the market, the supply might further increase to compensate the higher demand at a greater price. So, as a result of these expectations, the quantity would be traded in the current period at higher prices.

Therefore, statement 2 is true.

Hence, option (C) would be the right answer.

14. A straight line downward falling demand curve shows different combinations of price and output, for which the expenditure incurred, remains the same. That means, the demand curve will be a rectangular hyperbola.

This kind of demand curve have absolute price elasticity as constant and equal to one, because the percentage change in price would be same as the percentage change in demand such that the expenditure remains constant.

So, option (A) will be the correct answer.

15. If for a good the absolute price elasticity of demand is greater than unity, then it is known as elastic demand, for which a slight change in the price level changes the demand by great extent.

If the price falls for this elastic demand, then the quantity rises by a very large amount following the law of demand. So, as a result the expenditure would rise and since with the rise in quantity demanded the revenue also rises, the marginal revenue would be greater than zero.

Option (A) is the correct answer.

16. Now, if the price elasticity of demand for a good is less than unity, then even a large change in the price does not change the quantity demanded by that much.

So, if the price falls by a large amount, then the quantity does not raise much; for which we could expect that the fall in price outweigh the rise in demand and so the revenue falls. And as the revenue fall with the rise in quantity, we could say that the marginal revenue falls below zero.

So, option (B) is the correct option.

17. A management would offer “Happy Hour” or lower prices, when they see that the lowering of prices would benefit them by greater increase in the sale of their products, as that would lead to increase in revenue and so the profit.

As we had already discussed, the huge increase in revenue due to a slight lowering of prices would be possible if the demand is very much elastic. Therefore, we could believe that the Smoke Offer management thinks that the demand is elastic on Saturdays through Wednesday. And so in turn they thinks that the demand is less elastic for the remaining days, that is, Thursdays through Friday after 9 PM.

Thus, option (A) is the right answer.

18. The supply of goods depends on the time factor to a great extent as it takes time for the supply to adjust with the changing scenario cause most of the production decisions are made beforehand. So, a change in the price level does not change the supply instantly, it changes with some time lag.

Therefore, if the consideration of the time is shorter, then the supply of goods do not get enough space to change the key decisions regarding the production and marketing of the goods and so it is less responsive with the change in the price.

So, option (A) is the correct option.

19. Now, if the market shares for inputs are larger, then even at a shorter period of time, the production could change and so the supply could reach its required level or at least near the required level due to the change in the market price. Therefore, with the change in price, the supply could be more responsive if the shares of inputs are larger in market.

Therefore, option (B) is the correct option.

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