Question 1. Suppose you are in charge of sales at a pharmaceutical company, and your
firm has a new drug that causes bald men to grow hair. Assume that the company wants
to earn as much revenue as possible from this drug. If the elasticity of demand for your
company’s product at the current price is 1.4, would you advise the company to raise the
price, lower the price, or to keep the price the same? What if the elasticity were 0.6?
What if it were 1? Explain your answer.
Question 2. Automobile manufacturing is an industry subject to significant economies
of scale. Suppose there are four domestic auto manufacturers, but the demand for
domestic autos is no more than 2.5 times the quantity produced at the bottom of the
long-run average cost curve. What do you expect will happen to the domestic auto
industry in the long run?
Question 3. Imagine that the government statisticians who calculate the inflation rate
have been updating the basic basket of goods once every 10 years, but now they decide
to update it every five years. How will this change affect the amount of substitution bias
and quality/new goods bias?
