Economics – Dr.

Katie Sauer
In Class Assignment4: ch 5

1. The elasticity of Demand is an important determinant of how a firm’s revenues respond if prices are
changed.
a. Suppose the RTD bus company claims they need to increase their fares to increase their
revenues to off-set the higher price of gas. You’ve done some checking and know that the
elasticity of demand for bus rides is 1.5. Is the bus company correct? Why or why not?

b. You are the pricing manager of a firm selling ball point pens. You know that elasticity of
demand for your product is 0.75. If you want to increase your revenues, should you raise or
lower the price of pens? Why?

c. If the elasticity of demand is 1, and the price of the product decreases by 15%, what will
happen to total revenues? What will happen to quantity demanded?

2. Suppose that the quantity of white wine falls by 10% and the cross price elasticity between white
wine and salmon is equal to -4. Did the price of salmon rise or fall to cause the change in quantity? By
what percent? Are white wine and salmon substitutes or complements?

3. Suppose that your income increases by 5% and your income elasticity for rice is equal to -2. Did
your quantity demanded for rice increase or decrease in response to your income change? By what
percent? In this example, is rice a normal or inferior good?

4. Suppose that as the price of sunglasses increases from $75 to $85, Ray Ban increases production
from 1000 to 1200 pairs per day. What type of elasticity can you compute? Compute the elasticity.
What can you conclude about the elasticity value?

5. Under the 1997 tobacco settlement, if teen smoking doesn’t decrease 60% by 2007, cigarette
manufacturers will be fined $2billion. As a result of the 1997 settlement, cigarette prices increased
about 25% per pack. Teen cigarette price elasticity of demand is estimated to be 1.3. Will the 25%
increase in price be enough to decrease the teen smoking by 60%? Explain.
6. In the short run, the number of apartments in Boulder is fixed. That is, today, there are a certain
number of rental units in town. Demand for apartments is inversely related to rent costs. As rent is
cheaper, more people are willing and able to rent apartments.

a. Given the above information, graph the demand and supply curves for apartments. Instead of
price, label the vertical axis “rent”. On your graph, label equilibrium rent and quantity of
apartments being rented.

b. Suppose CU and Naropa both increase admissions and as a result, the demand for apartments
in Boulder increases. Illustrate this on your graph from part “a”. Be sure to label the new
equilibrium rent and quantity of apartments being rented.

c. What happened to equilibrium rent and quantity? Why?

d. The new higher rents are attractive to landlords. Over time, they build more apartment
buildings. (The Law of Supply, right? --- as rent goes up, the quantity supplied increases) The
long run supply curve for apartments is much more elastic than the short run supply curve. On
your graph in part “a”:
- first, label your existing supply curve with a “SR” subscript to indicate the short run
- next, draw the long run supply curve for apartments (label with an “LR”), be sure that
the long run supply curve passes through the original equilibrium from part “a”.

e. On your graph in part “a”, illustrate the equilibrium rent and quantity of apartments rented in
the long run (after the increase in demand). Explain how this is different than the short run.