Ch 5 : Problems and Applications

• 1. More Elastic? : • A. Mystery novels or required text• Mystery novels• Have more close substitutes• May be considered a luxury • B. Beethoven or Classical Music• Beethoven - more narrowly defined market –

can find more close substitutes

• C. Heating Oil (over 5 years or 6 months) • Over 5 years – can adjust habits / find

substitutes• D. Root Beer or Water • Root beer – may be considered luxury / can

find more close substitutes

• 2. A. P up from $200 to $250 • Business travelers 1900 – 2000 / 2000 .05 5% $250 - $200 / 200 .25 25% PED = .2 = InelasticVacationers600-800 / 800 .25 25%$250 - $200 / 200 .25 25% PED = 1 = unit elastic

• B. Vacationers PED is more elastic than business travelers because…..

• Luxury vs. necessity

• 3. at income of $10,000 P of CD up from $8 to $10

32-40 / 40 = .2 20%$10-$8/$8 = .25 25% = PED = .8 Inelastic

• When income is $12,00045-50/50 = .10 10%$10-$8 / $8 = .25 25%= PED .4 inelastic

B. IED : Income up $10 k - $12 k when P = $1230-24/24 = 25%$12k - $10k / $10k = 20%= IED + 1.25 Elastic, Normal

• IED Income up $10k to $12 k when P $1612-8/8 50%$12k - $10k / $10k 20%IED = + 2.5 Elastic, Normal

• 4. A. Emily always spends 1/3 of income on clothing

• If she always spends 1/3 of income …then any change in her income would result in an equal % change in her D…so IED….. =

• 1• B. PED? • For every 1% increase in P, then would be 1%

change in D to maintain her 1/3 spending of income

• PED = 1

• If change taste and now spends ¼ of income .....how does D curve change

• D curve shifts left…at every P, D is now less• What is IED and PED now???• Still 1

5. million fewer riders in Dec… a 4.3% declineAfter P increased 25 cents to $1.50 A. PED? 4.3%$1.50-$1.25 / $1.25 = 20%= PED .215 = inelastic B. What happens to revenue? If PED is inelastic and P increases = TR increases

• C. Why might PED estimate be unreliable ? • It has only been 1 month after P increase• As time passes, people may find alternatives

and therefore it becomes More Elastic

• 6. Before looking at Price, Tom says I’d like 10 gallons of gas.

• Toms PED = ?• 0 Perfectly Inelastic…explain • He will buy same Q (10 gal) no matter what the

price• Jerry says I’d like $10 worth of gas• Jerry’s PED = ? • 1 unit elastic…explain • He will spend $10 no matter what the P is…if the P

has risen, QD will fall at same ratio

• 7. spending on restaurant meals declines more during economic downturns than does spending on food to be eaten at home. Explain –

• Econ downturns = decrease in income• Expect a decrease in income to result in a

larger decrease in D for restaurants than a decrease in food at home

• = Luxury vs. necessity

Cross Price Elasticity Examples

• P of X increases from $8-$10. • D of Y decreased from 20 to 18 units. • Calculate the Cross Price Elasticity for good Y. • What type of goods are X and Y? 18-20/20 - 10%$10-$8/$8 25%= XPED -.4 inelastic (complimentary goods)

P of Z increases from $10 to $11. D of Y increased from 25 units to 30 units.Calculate the Cross Price Elasticity for good Y. What type of goods are Z and Y ?

Y: 30-25/25 20%X: $11-10/10 10%= XPED +2 elastic (substitutes)