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CHAPTER 6
Questions for Thought and Review
2.
I would check to see if other things remained equal, suspecting that they did not, since the rise in price did
not have the expected effect. If all other things did indeed remain equal, the elasticity would be zero.
4.
Price elasticity of demand is equal to the percentage change in quantity divided by the percentage change in
price. Pizzas went from $8 to $2 and quantity from 1 to 100. The price elasticity of demand is (1.96/1.2) =
1.60.
6.
They are both the same. Any supply curve that goes through the origin has an elasticity of 1.
8.
To the degree that colleges are trying to get as much revenue as possible, they will keep raising tuition until
the demand is no longer inelastic. Colleges don’t raise their tuition by more than what they currently do
because they are not profit maximizers, and because social pressures such as student protests would result if
they raised tuition too much.
10. More eager students will agree to go to a school even if they don’t get much financial aid. That is, they have
less elastic demands and thus will tend to get less financial aid. Whether this practice is justified is a difficult
normative issue, with many alternative views.
12. a.
b.
c.
d.
e.
f.
Vodka: normal, luxury (except in Russia). Individuals tend to drink more hard liquor as their income
rises. (It depends on the type: Absolut vodka is more of a luxury than store brands.)
Table salt: normal, necessity. It is a small portion of people’s income, and its consumption doesn’t
increase with income.
Furniture: normal, luxury (depends on the type). While we all need some furniture, the wealthy spend
large sums on furniture. The rest of us get by with cheap stuff.
Perfume: normal, luxury (depends on the type). The rich blow money on perfume; the rest of us get by
with toilet water, or we smell a bit.
Beer: normal, inferior. Beer, the cheapest type of alcohol, tends to be the poor person’s drink. As
income increases, beer drinkers will choose to drink less beer and more expensive alcohol such as wine
and liquor. However, new micro breweries are trying to change beer’s image, and to make certain types
of beer be seen as a luxury.
Sugar: normal, necessity. It is not used significantly more by rich than by poor.
14. If there were only two (assuming no saving) the goods must be substitutes because if a person doesn’t
consume one, he or she would have to consume the other.
16. To answer this question, use the formula from the chapter: percentage change in price = percentage change
in supply divided by sum of demand and supply elasticities. Here, percentage change in price = 5/(1 + .2) =
4.17 percent. The pre-terrorism price was $1.75, so the new price is 1.04 31.75 = $1.82.
Problems and Exercises
2.
a.
b.
4.
a.
b.
Using standard reasoning, we would answer that firms decreased the size of the coffee cans to hide
price increases from consumers. However, in reality people often react differently to changes in the size
of packages compared to the equivalent change in price.
Examples include candy bars, soap, and canned tuna fish.
A price rise of 10 percent will reduce fuel consumption anywhere from 4 to 8.5 percent. Quantity
demanded would range from 9.15 to 9.6 million gallons.
This suggests that there are other forces besides price at work here; making adjustments to higher prices
is much easier than making adjustments to lower prices. This may be due to learning the true cost of
substitutes when those substitutes are consumed. One can imagine a scenario in which a price hike
significantly changes driving behavior—commuters may switch to ride sharing or public transportation,
to which there may be perceived social barriers (costs). Once those barriers are overcome and the
perceived costs are lowered after those alternatives are used, a larger decline in the price of gasoline is
required to induce those who switched to return to driving their own cars.
6.
8.
Point A: 3; point B: 1/3; point C: 3/2; point D: 7/6.
a.
10. a.
b.
c.
b. 0.60
Neither state is maximizing revenue. Maximum revenue is collected when elasticity is one. Both are
collecting less than the maximum revenue: in California elasticity is less than one and in Massachusetts
elasticity is greater than one.
I would recommend that Massachusetts lower its price and California raise its price.
Massachusetts, because not only is it not collecting maximum revenue, it could simultaneously lower
price and increase revenues, making both those who buy vanity plates and the treasury happy.
Elasticity of demand equals one at price P* in the accompanying graph. California is below at a price
such as P1, where demand is inelastic. So, you can see that raising the price from prices below P 1 will
result in greater revenue gained (BC) than lost (F). Massachusetts is at a price above P*, such as P0,
where demand is elastic. So you can see that lowering the price to P* will result in greater revenue
gained (CE) than lost (A).
Price
d.
0.5
P0
A
P*
B
C
D
E
P1
Q0
12. a.
b.
c.
14. a.
b.
16. a.
b.
c.
Demand
F
Q*
Q1
Quantity
Peak hour travelers are likely to be commuters who have little choice but to go to work and therefore
have lower demand elasticity than those who ride busses during off-peak hours, and are more likely
using buses for errands or other more discretionary activities.
Demand tends to be less elastic in the short run because there are few substitutes. If fares rose enough,
in the long run people could find alternative modes of transportation – purchase a car, find someone to
share rides with, etc.
Tolls are likely a much smaller portion of high income commuter’s total income, contributing to a lesselastic demand.
Liquor producers would not support a tax on beer because the cross-price elasticity between beer and
hard liquor is negative. The beer tax would also reduce liquor consumption.
Wine producers would support a tax on beer because the cross-price elasticity between beer and wine is
positive. The beer tax would increase wine consumption.
0.31 (40,000/260,000)/(20/40).
Since the demand is inelastic, it doesn’t make sense to lower the price because it reduces the total
revenue.
Then it makes sense to lower the price in order to increase the circulation for more advertising revenue.
Web Questions
2.
a.
$5.50 to $8.50 by 2003 and $10.50 by 2007 which is about a 55 percent increase initially and a 91
percent increase by 2007. The estimate of labor demand elasticity used is 0.22. Inelastic.
Labor costs will be raised $6.6 million per year. Since demand is inelastic, a rise in the minimum wage
will raise total labor costs. The two are consistent. If elasticity of demand were greater than one, one
would expect labor costs to fall when the minimum wage is raised.
In the long-run firms can keep labor costs down by hiring fewer workers and by finding substitutes for
labor, such as outsourcing or automation. What accounts for the difference is that in the long run, all
factors of production are variable. In the short run, firms have fewer substitutes in production and will
have to accept the higher labor costs. Source: The Effects of the Proposed Santa Fe Minimum Wage
Increase, by David McPherson.