# Eco550 Week 2 Check Your Understanding

**Topics:**Supply and demand, Consumer theory, Price elasticity of demand

**Pages:**3 (851 words)

**Published:**July 21, 2013

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* Chapter 3: Problems 3, 4, and 7

Chapter 3 -Problem 3 Answer: The Olde Yogurt Factory has reduced the price of its popular Mmmm Sundae from $2.25 to $1.75. As a result, the firm’s daily sales of these sundaes have increased from 1,500/day to 1,800/day. Compute the arc price elasticity of demand over this price and consumption quantity range. Arc Price Elasticity = (Q₂ - Q₁ / P₂ - P₁) * (P₂ + P₁ / Q₂ + Q₁) Q₁ = 1500

Q₂ = 1800

P₁ = 2.25

P₂ = 1.75

Answer: [(1800 - 1500)/(1.75 – 2.25)] * [(1.75 +2.25)/ (1800 + 1500)] (300/-.5) * (4/3300) = 1200/-1650 = -.7272

Chapter 3 -Problem 4 Answer: The subway fare in your town has just been increased from a current level of 50 cent to $1.00 per ride. As a result, the transit authority notes a decline in ridership of 30 percent. * Compute the price elasticity of demand for subway rides. Answer: Price Elasticity of demand = %∆Q / %∆P = .30/ (.50/1.00) = .30/.50 = .60 * If the transit authority reduces the fare back to 50 cents, what impact would you expect on the ridership? Why? Answer: Price Elasticity of demand = %∆Q / %∆P = .30/ (1.00/.50) = .30/.20 = .15 Because the elasticity of demand is less than 1, it is considered inelastic. Therefore, an decrease in price would be a decrease in revenue. Chapter 3 -Problem 7 Answer: In an attempt to increase revenues and profits, a firm is considering a 4 percent increase in price and an 11 percent increase in advertising. If the price elasticity of demand is -1.5 and the advertising elasticity of demand is +.06, would you expect an increase or decrease in total revenues? Answer: Because the price elasticity of demand is -1.5 the absolute values of the price elasticity of demand is elastic. Therefore, with a 4% increase in price, there would be a decrease in quantity sold. The reduction in quantity would then cause a...

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