## The following equation represents the demand for a stylish diamond ring:

QD = 22500 – 1.5 PD + PS + 0.25 Y

QD is quantity demanded; PD is the average price of the good itself; PS is the average price of a substitute good; and Y is average personal income.

a. Plot the demand curve by assuming that PS is equal to €3,750, Y is equal to €5,000, and the price PD takes a value from €2,000 up to €6,000. Does the demand function conform to the law of demand? Explain your answer.

b. By assuming that PS is equal to €3,750 and Y is equal to €5,000, find the elasticity of demand with respect to price PD when PD is equal to

(i) €4,000 and

(ii) €6,000. Explain how the price elasticity of demand changes with the price level.

c. If Y increases to €10,000, would you expect any changes in the price elasticity of demand when PD is equal to €4,000 and €6,000? If no, why? If yes, discuss the changes between the elasticities.

Suppose that the supply equation for the same good is:

Qs = 900 + 3 PD + T;

Qs is quantity supplied;

PD is the average price of the good itself; and

T is an index of technology.

d. Assuming that T takes the value of 5000 and the price PD takes a value from €2,000 up to €6,000, plot the supply curve on the same graph paper where you plotted the demand curve. Find the equilibrium price and quantity.

e. Mention and discuss FOUR factors that determine the demand of diamond rings and FOUR factors that determine the supply of the same good.

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