Ay Swors Elasticity 1, TheNile.com, the online bookseller, wants to increase its total revenue, Currently, every book it sells is priced at $10.50. One suggested strategy i to offer a discount that lowers the price of a book to $9.50, a 10% reduction in price using the midpoint ‘method, TheNile.com knows that its customers'can be divided into two distinct ‘groups according to thei likely responses to the discount. The accompanying table shows how the two groups respond to the discount. Group A Group 8 (Gales per week) (ales per week) Volume of sales before the 10% discount 1.55 million 1.50 milton Volume of sles after the 10% discount 1.65 million 1.70 milton ‘a, Using the midpoint method, calculate the price elasticities of demand for Group A and Group B. ». Explain how the discount will affect total revenue from each group. . Suppose TheNile.com knows which group each customer belongs to when he or she logs on and can choose whether or not to offer the 10% discount. If ‘TheNile.com wants to increase its total revenue, should discounts be offered to Group A or to Group B, to neither group, or to both groups? 14), Using the ido Group Als 1,65 million = 1,55 million 0.4 million (4.55 million + 1.65 million)/2 * 10 7,6 milion * 10°" 625% ce the change in price is 10%, the price elasticity of demand for Group Ais, ‘method, the percent change in the quantity demanded by and 6.25% dS = 0.625 Using the midpoint method, the percent change in the quantity demanded by Group Bis ‘ 41.7 million ~ 1.5 million : n G5 million + 1,7 million)/2 * 1.6 million ‘and since the change in price is 10%, the price elasticity of demand for Group B is 12.5% 4.25 10% b. For Group A, since the price elasticity of demand is 0.625 (demand is inelastic), total revenue will decrease as a result of the discount. For Group B, since the price elasticity of demand is 1.25 (demand is elastic), total revenue will increase as a re- sult of the discount, ‘© If TheNile.com wants to increase total revenue then it should definitely not offer the discount to Group A and it should definitely offer the discount to Group B. 100 = 2-2:million x 100 = 12.5% 2. Do you think the price elasticity of demand for Ford sport-utility vehicles (SUVs) will increase, decrease, or remain the same when each of the following events occurs? Ex- plain your answer. a, Other car manufacturers, such as General Motors, decide to make and sell SUVs, m172 CHAPTER 5 », SUVs produced in foreign countries are banned from the American market. Due to ad campaigns, Americans believe that SUVs are much safer than ordinary passenger cars. 4. The time period over which you measure the elasticity lengthens. During that longer time, new models such as four-wheel-drive cargo vans appear, a. The price elasticity of demand for Ford SUVs will increase because more substitutes are available. Jeske 'b. The price elasticity of demand for Ford SUVs will decrease because fewer substitutes fiscleshe > Less are available. Then } . The price clasticity of demand for Ford SUVs will decrease because other cars are viewed as less of a substitute. 4. The price elasticity of demand for Ford SUVs will increase over time because more substitutes (such as four-wheel-drive cargo vans) become available, 3. U.S. winter wheat production increased dramatically in 1999 after a bumper harvest. Elect: ‘The supply curve shifted rightward; as a result, the price decreased and the quantity astie demanded increased (a movement along the demand curve). The accompanying table describes what happened to prices and the quantity demanded of wheat. os | 1998 i869 Quantity demanded (bushels) 1.74 billion 1.9 billion ‘Average price (per bushel) $3.70 $2.72 a. Using the midpoint method, calculate the price elasticity of demand for winter wheat, b. What is the total revenue for U.S. wheat farmers in 1998 and 199? © Did the bumper harvest increase or decrease the total revenue of American wheat farmers? How could you have predicted this from your answer to part a? 3. a. Using the midpoint method, the percent change in the quantity demanded of US. winter wheat is 19 billion = 1,74 billion 445 _ 016 billion (1.74 billion + 1.9 billion)/2 * 1.82 billion and the percent change in the price of USS. winter wheat is $3.70 - $2.72 _ $0.98 (53.70 + $2,72)72 * 100 = $3-97 * 100 = 30.5% % 100 = 8.8% ‘The price elasticity of demand is therefore 8.8% _ Be -0.29 b, The total revenue in 1998 is the price per bushel in 1998 times the quantity of bushels demanded in 1998. That is total revenuc in 1998 is $3.70 1.74 billion = §6.438 bil- lion, Similarly, total revenue in 1999 is $2.72 x 1.9 billion = $5.168 billion. The fall in price from 1998 to 1999 reduced U.S. wheat farmers! total revenue. This could have been predicted by knowing that demand is inelastic: in part a we caleu- lated a price elasticity of demand of 0.29. In this case, the price effect of this price fall (which tends to reduce total revenue) outweighed the quantity effect (which tends to increase total revenue).74 CHAPTER 5. 5. 5. ‘The accompanying table lists the cross-price elasticities of demand for several goods, ‘where the percent price change is measured for the first good of the pair, and the per- cent quantity change is measured for the second good, Cross-price elasticities Good of demand Air-conditioning units and kilowatts 0.34 of electricity Coke and Pepsi 40.63 High-fuel-consuming sport-utiity ~0.28 vehicles (SUWs) and gasoline McDonald's burgers and Burger King 40.82 burgers Butter and margarine 154 a. Explain the sign of each of the cross-price elasticities. What does it imply about the relationship between the two goods in question? ». Compare the absolute values of the cross-price elasticities and explain their magni- tudes. For example, why is the ctoss-price elasticity of McDonald's and Burger King less than the cross-elastcity of butter and margarine? . Use the information in the table to calculate how a 5% increase in the price of Pepsi affects the quantity of Coke demanded. 4, Use the information in the table to calculate how a 10% decrease in the price of gasoline affects the quantity of SUVs demanded. a. A negative cross-price elasticity of demand implies that the two goods are comple- ments. So air-conditioning units and kilowatts of electricity are complements, as. are sport-utility vehicles and gasoline. A positive cross-price elasticity of demand implies that the two goods are substitutes. So Coke and Pepsi are substitutes, as are McDonald's and Burger King burgers as well as butter and margarine. ‘The larger (and positive) the cross-price elasticity of demand fs, the more closely the two goods are substitutes. Since the cross-price elasticity of butter and mar- sgarine is larger than the cross-price elasticity of McDonald's burgers and Burger King burgers, butter and margarine are closer substitutes than are McDonald's and Burger King burgers. Similarly the greater (and negative) the cross-price elasticity cof demand is, the more strongly the two goods are complements. A cross-price elasticity of 0.63 implies that a 1% increase in the price of Pepsi would increase the quantity of Coke demanded by 0.639%. Therefore, a 5% increase in the price of Peps! would increase the quantity of Coke demanded by five times as uch, that i, by 5 0.63% = 3.15%. 4. A cross-price elasticity of -0.28 implies that a 1% fall in the price of gasoline would Increase the quantity of SUVs demanded by 0.28%. Therefore, a 10% fall in the price of gasoline would increase the quantity of SUVs demanded by 10 times as, much, that is, by 10% 0.28% = 2.8%, b. « ‘What can you conclude about the price elasticity of demand in each of the foll statements? ing “The plaza delivery business in this town is very competitive. I'd lose half my cus- tomers if | raised the price by as little as 10%." ». “Lowned both of the two Jerry Garcia autographed lithographs in existence. I sold ‘one on eBay for a high price. But when I sold the second one, the price dropped a lot.”Tackle the Test: Multiple-Choice Questions 1, A perfect elastic demand curve is Aw Sie Yr o eee upward oping (Ce) The demand curve is vertical vera The demand curves horizontal __& novastraighe line €. The price of he good is igh Co) horizon 4. Which ofthe followings correct Fora price increase? When ‘downward sloping — Seer demand is, _ revenue will _ 2. Which of the Following would cause the demand fora good Demand Tel Revenue be relatively inelastic? 4 incase decrease 4 The good has large numberof close substitutes D atasic dlecrense bs Expendizaes onthe good represent large share of © unieelasie increase consumer income 4. unieeasie decrease «Therein ample ime to adjust to price changes. © dassc increase Me good isa neces al revenues maximized when demand is Dhepecartpalbindeuperieeaootatnn Tenn macnn dean domadecurre , inelastic, 3. Which ofthe fllowingistueifthe price csicyyofdemand —_("e)wnitelastie. fora soo iszeo? 200 innit. 4 Theslope of rhe demand curve is zero, ——— = 1 ifthe oss prie elaticy bexween two goods i negative, this seas that the two goods are 4 subsites. complements normal & infeior. luxuries 2. If yie buys 200 units of god X when her income ie $20,000 and 300 units of good X when her income increases to $25 00, ter income elasticity of demand, using the midpoine method, is a 006. b. os. e148. Oia 20. 3. The income elasticity of demand for anormal good is ba. & infinite. D positive 4 A perfecdyelasic supply curve is 2 positively sloped b. negatively sloped. vertical horizontal fe. Usshaped 5. Which of he Following leads vo a more inelastic price lasiciy of supply? 1. the use of inputs that ate easily obtained 1a high degree of subsecuabiity berween inputs 1a shorer cme period in which to supply the good a. Tonly b. tronly @itonly & tandif only e bihand ittTackle the Test: Free-Response Questions 2. Draw acorsectly labeled graph illustrating a demand curve ‘hat isa straight line and is neither perfectly elastic nor rah 2. As the price of margarine rises by 20%, a manufactuter baked perfectly inelastic ood incteases its quantity of butter demanded by 5% = Gin-youe graph indlicare che-halff he demand surweshan§ ———$—=eralaoe tae ORT ‘of demand between butter which demand is elastic. and margarine. Are butter and margarine substitutes oF bb In he elastic range, how will an increase in price affect oral complements for this manufacture? revenue? Explain. Tackle the Test: 2, The cross-prce elasticity of demand is 5%/20% = 0.25 Free-Response Questions Since the cross-price elasticity of demand is postive, the Ae ‘two goods are substitutes at ted ‘uot », An increase in price will decrease total revenue because the negative quantity effect of the price increase is greater than the positive price effect of the price increase,