Sunday, September 9, 2007

Assignment 4



1. For each of the following pairs of goods,which good you expect to have more elastic demand and why?
a) Required textbooks or mystery novels.
b) Beethoven recordings or classical music recordings in general.
c) subway rides during the next 6 months or subway rides during the next 5 years
d) root beer or water
Ans :
a) Required textbooks or mystery novels - Mystery novels will have more elastic demand because they are not necessities compared to textbooks. We cannot do away with textbooks as they are necessary to complete a particular subject. As a result textbooks will have a inelastic demand relative to the mystery novels.
b) Beethoven recordings or classical music recordings in general - Beethoven recordings are more narowly defined form of music. Narrowly defined things have more substitutes and so are more elastic in demand
c) Price elasticity is higher in the long run than in short run. It might be possible to find more substitutes for rides during the next 5 years. So subway rides during the next 5 years will be more elastic.
d) Water is a necessity and does not have a close substitute. So water will have less elastic demand compared to root beer which is not a necessity and also have more close substitutes.
2. Suppose that business travelers and vacationers have the following demand for airline tickets from New York to Boston:

style='margin-left:18.5pt;border-collapse:collapse;mso-padding-alt:0in .5pt 0in .5pt'>


























Price



Quantity Demanded
(Business Travelers)



Quantity Demanded
(Vacationers)



150



style='mso-spacerun:yes'>           2100 tickets



style='mso-spacerun:yes'>           1000 tickets



200



2000



800



250



1900



600



300



1800



400




a) As the price of tickets rises from $200 to $250, what is the price elasticity of demand for (i) business travelers and (ii) vacationers? (Use the midpoint formula in your calculations.)
b) Why might vacationers have a different elasticity from business travelers?
Ans:
a)
i) Price elasticity for business travellers
= (Q2-Q1)/[(Q2+Q1)/2]/(P2-P1)/[(P2+P1)/2]
= [(1900-2000)/1950]/[(250-200)/225]
= -0.23
Therefore, elasticity = |-0.23| = 0.23

ii) Price elasticity for vacationers = (Q2-Q1)/[(Q2+Q1)/2]/(P2-P1)/[(P2+P1)/2]
= [(600-800)/700]/[(250-200)/225]
= -1.29
Therefore, elasticity = |-1.29| = 1.29
b) For vacationers, travel is of less necessity compared to business travellers. Vacationers have longer time horizon for travel while the business travellers have a very short time to travel. Vacationers also have several other subsitutes like travelling by car. That substitute is not appropiate for business travellers as they need to reach faster to their place of destination.
This is why vacationers will have a higher elasticity of demand for air tickets compared to the business travellers
3. Suppose the price elasticity of gasoline is 0.3 in the short run and 0.9 in the long run.
a) If the price of a gallon of gasoline falls from $2.50 to $2.25, what happens to the quantity of gasoline demanded in the short run ?In the long run ?(Use the midpoint formula in your calculations.)
b) Why might the elasticity of demand for gasoline depend on time horizon?

Ans : a) The percentage change in price = (2.25 - 2.50)/2.375 = 0.11 = 11%. The price elasticity in the short term is 0.3, so quantity demanded will rise by 0.3*.11 =33%. Since the long run elasticity is 0.9, it will rise by 0.9*0.11 = 99% in the long run.
b) Overtime people might prefer to drive their cars to work instead of car pooling, because they might see more value in that. As the gas price has decreased, driving their own car will not cost much and also they will be more independent regarding when to start or or leave from office.
4. Suppose that your demand scheduled for T shirt is as follows
style='margin-left:18.5pt;border-collapse:collapse;mso-padding-alt:0in .5pt 0in .5pt'>































Price



Quantity Demanded
(Income-$12000)



Quantity Demanded (Income-$15000)



$5



style='mso-spacerun:yes'>           20 Tshirts



style='mso-spacerun:yes'>           25 Tshirts



8



16



22



11



12



19



14



8



16



              17



style='mso-spacerun:yes'>                               4



                      
13



a. Use the midpoint method to calculate your price elasticity of demand as the price of T shirts increases from $5 to $8 if (i)your income is $12000 and ii)your income is $15000.
b.Calculate your income elasticity of demand as your income rises from $12000 to $15000 if (i) the price is $14 and (ii) the price is $17
Ans : a) If your income is $12000, the price elasticity of demand when price increases from $5 to $8 is [(16-20)/18]/[(8-5)/6.5] = 0.48

If your income is $15000, the price elasticity of demand when price increases from $5 to $8 is [(22-25)/23.5]/[(8-5)/6.5] = 0.28
b)Income elasticity at price $14 = [(16-8)/12]/[(15000-12000)/13500] = 3
Income elasticity at price $17 = [(13-4)/8.5]/[(15000-12000)/13500] = 4.76

5. Maria has decided always to spend one-third of her income on clothing
a) What is her income elasticity of clothing demand ?
b) What is her price elasticity of clothing demand ?
c) If Maria's tastes change and she decides to spend only 1/4 of her income on clothing,how does her demand curve change? What is her income elasticity and price elasticity now?

Ans:
a) Her income elasticity of clothing demand will be 1. This is because since she is spending a constant fraction of her income, her percentage change in clothing demand must equal to her percentage change in income. Suppose her income is $6000 and price of clothing is $2, then she buys 1000 clothes. If her income rises by 5% it becomes 6300 and she buys 1050 clothes, a 5%increase in demand.

b)The price elasticity of her clothing demand will also be 1. An increase in the price of clothes would lead to reduce her purchase by the same percentage. Suppose the price of clothing is $2 and her income is $6000, she will buy 1000 clothes. If the price increases by 1%, she will buy 990 clothes which is a 1% reduction.

c) Since she will now spend less on clothes, for any given price she will buy less clothes. He demand curve will shift to the left . But becasue she will still spend a fixed portion of her inclome on clothing, her income and price elasticity of demand will still be 1.

6. The New York Times reported(Feb 17 1996 P 25) that subway ridership declined after a fare increase: "There were nearly four million fewer riders in December 1995, the first full month after the price of a token increased 25 cents to $1.50, than in the previous December, a 4.3 percent decline."
a. Use these data to estimate the price elasticity of demand for subway rides.
b. According to your estimate , what happens to the Transit Authority's revenue when the fare rises?
c.Why might your estimate of the elasticity be unreliable?

Ans:
a. The percentage price increase = 0.25/1.25 = 20%, The price elasticity of demand of subway rides = 4.3/20 = 0.215 which is inelastic
b. Since the demand is inelastic, the total revenue of Transit Authority will rise.
c. The elasticity is unreliable because the elasticity is calculated over a short period(only the first month after the fare increase). In the long run people might switch other means of transportation which might increase the price elasticity of demand and reduce the total revenue.

7.Two drivers - Tom and Jerry-each drive up to a gas station .Before looking at the price ,each places an order.Tom says ."I'd like 10 gallons of gas."Jerry says ,"I'd like $10 worth of gas." what is each driver's price elasticity of demand?

Ans: The price elasticity of Tom's demand is zero because his quantity of demand always remains the same irrespective of the price.

The price elasticity of Jerry's demand is 1 because he spends the same amount of money on gas irrespective of the price.which means his percentage change in quantity is equal to the percentage change on price.

8.Consider public policy aimed at smoking.
a.Studies indicate that the price elasticity of demand for cigarretes is about 0.4. If a pack of cigarretes currently costs $2 and the government wants to reduce smoking by 20 percent, by how much should it increase the price.

b.If the governement permanently increases the price of cigarrettes, will the policy have a larger effect on smoking 1 year from now or 5 years from now?

c. Studies also find that teenagers have a higher price elasticity than do adults. Why might this be true?

Ans: a) Pice elasticity = %change in quantity demanded/%change in price. Since the price elasticity = 0.4, to reduce the quantity demanded to 20% will require a 50% increase in price(0.4 = 20/%change in price, %change in price = 20/0.4 = 50). Using the midpoint method, the new price should be as below

X2-2/(X2+2)/2 = 0.50.

So, X2(new price) should be $3.33.

9. You are the curator of a museum. The museum is running short of funds,so you decide to increase revenue.Should you increase or decrease the price of admission? Explain.

Ans : This depends on the price elasticity of demand
If the demand for visiting meuseums is inelastic, the price should be increased
If the demand for visiting meuseums is elastic, the price should be decreased

10.Corn has a elastic demand and gasoline has an inelastic demand. Suppose that the government places a tax on each product that lowers the supply of each product by half (that is ,the quantity supplied at each price is 50 percent of what it was)
a. What happens to the equilibrium price and quantity in each market?
b. Which product experiences a larger change in price?
c. Which product experiences a larger change in quantity?
d. What happens to total consumer spending on each product?

Ans:
a. The decrease in supply will raise the equivalent price but reduce the equivalent quantity in both the markets. But the increase in equivalent price will be more in the market of gasoline which has an inelastic demand. The decrease in equivalent quantity will be more in the market of corn which is elastic in nature.
b. The market of gasoline will experience a larger change in price.
c. The market of corn will experience a greater change in quantity
d.In the market of gasoline the %increase in price will be more than the % decrease in quantity demanded. So, the total consumer spending will increase in this market.

In the market of corn the %increase in price will be less than the %decrease in quantity demanded. So, the total consumer spending will decrease in this market.

11. Beachfront resorts have an inelastic supply,and automobiles have an elastic supply. Suppose that a rise in population doubles the demand for both products (that is, the quantity demanded at each price is twice what it was).
a. What happens to the equilibrium price and quantity in each market ?
b. Which product experiences a larger change in price ?
c. Which product experiences a larger change in quantity ?
d. What happens to total consumer spending on each product ?

Ans:
a. The increase in demand will increase both equilibrium price and quantity
b. In the beachfront resorts market which is a inelastic supply, the increase in demand leads to a relativley large increase in price and less increase in quantity.
c. In the automobile market which is a elastic supply, the increase in demand leads to a relativley large increase in quantity and less increase in price.
d. Since both equilibrium price and quantity increase the consumer spending will increase.in both markets.

12. Several years ago,flooding along the Missouri and Mississippi rivers destroyed thousands of acres wheat.
a. Farmers whose crops were destroyed by the floods were much worse off, but farmers whose crops were not destroyed benefited from the floods. Why?
b. What information would you need about the market for wheat to assess whether farmers as a group were hurt or helped by the floods?

Ans :
a. Destruction of some of the crops reduced the supply which increased the eqilibrium price. This is the reason why farmers whose crops were not destroyed benefitted.
b. We need to know the price elasticity of demand for wheat .

13. Explain why the following might be true : A drought around the world raises the total revenue that farmers receive from the sale of grain, but a drofht only in Kansas reduces the total revenue that Kansas farmers receive.

Ans : World wide market is a broader market and people will not have much substitute for grain if we consider the world market as a result the demand will be inelastic. Due to the drought supply will reduce and it will increase the price. Since the demand is inelastic in this case total revenue will increase if the price is raised.

Kansas market is a subset of the world market and is narrowly defined. People will have options other than the Kansas market to buy the grains. So, in the case the price elasticity of demand will be elastic. Due to the drought supply will reduce, price will increase but since the price elasticity of demand is inelastic total revenue will fall in this case.

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