Assignment 1 – Answers – Q4
4. Suppose that an economist hypothesizes that the annual quantity demanded of a specific computer
brand (QD) is determined by the price of the computer (P) and the average income of consumers (Y)
according to QD = Y – 3P.
a. Which of these variables are endogenous and which are exogenous if we were interested in
constructing a theory that explains the determination of quantity demanded with emphasis on
the effect of price?
What is being studied and analysed is the quantity demanded for this computer brand. An
exogenous variable, in this context, is a variable that affects the quantity demanded without
being affected by it, and the determination of which is not specified by the model. Here, both
Y and P affect the quantity demanded without a mechanism being specified for how changes
in quantity demanded affects them (and it is not specified how Y and P are determined).
Therefore, in this context, both Y and P are exogenous. QD is the endogenous variable that is
being determined by the model specified.
b. What does the negative sign before the tem 3P imply about the relationship between QD and
P? What does the implicit positive sign before the term Y tell you about the relationship
between income and quantity demanded?
The negative sign indicates an inverse relationship between quantity demanded and price so
that an increase in price causes a decline in quantity demanded and decline in the price
result into and increase in quantity demanded.
The positive sign indicates a direct relationship between the quantity demanded and income
so that an increase in income causes an increase in quantity demanded and a decline in
income causes a decline in quantity demanded.
c. Suppose for the moment that average income is given and equals $6,000. Write a simplified
version of the demand relationship by inserting this value into the given expression above.
QD = 6000 – 3P.
d. Assuming that average income equals $6,000, calculate the values of QD when P = 0, P =
$500, P = $1,000, and P = $2,000.
DIY.
