Help for Questions for Critical Thinking 2

Topics: Supply and demand, Price elasticity of demand, Elasticity Pages: 8 (2324 words) Published: August 1, 2015
Questions for Critical Thinking 2: SOLUTIONS
Salvatore’s Chapter 4:

a. Discussion Questions: 8 and 11.

8. {5 points]
If the price increases by 10 percent, by how much does the quantity of household ( a) natural gas and ( b) electricity change in the short run and in the long run? ( Hint: Use the price- elasticity values in Table 4- 3.)

In general, . Using the numbers we have



11. [5 points]
Suppose that the cross- price elasticity of demand between McIntosh and Golden Delicious apples is 0.8, between apples and apple juice is 0.5, between apples and cheese is 0.4, and between apples and beer is 0.1. What can you say about the relationship between each set of commodities?

NOTE: Change “between apples and cheese is 0.4” to “between apples and cheese is negative 0.4.” The relationship between two commodities could be substitutes, complements, or independent.

Remember that a positive cross price elasticity implies the two goods are substitutes, and a negative implies they are complements.Also the closer is the elasticity to zero, the weaker is the relationship. So For McIntosh and Golden Declicious, a cross-price elasticity of 0.8 shows they are close substitutes. For apples and apple juice, a cross-price elasticity of 0.5 shows they are moderately strong substitutes. For apples and cheese, a cross-price elasticity of -0.4 (see note) shows they are moderate complements. For apples and beer, a cross-price elasticity of 0.1 shoes they are weak substitutes, or independent.

b. Problems: 3(a) and (b), 7, 9, and 15.

3. [5 points]
Starting with the estimated demand function for Chevrolets given in Problem 2, assume that the average value of the independent variables changes to N = 225 million, I = $ 12,000, P F = $ 10,000, P G = 100 cents, A = $ 250,000, and P I = 0 ( i. e., the incentives are phased out). ( a) Find the equation of the new demand curve for Chevrolets. ( b) Plot this new demand curve, D' C , and, on the same graph, plot the demand curve for Chevrolets, D C , found in Problem 2( d).

(a) = 1200000

Where Pc = 9000.

Revised P3(b). If Pc is $10,000, find the value of Qc.

(b) = 1100000

7. [5 points]
The total operating revenues of a public transportation authority are $ 100 million while its total operating costs are $ 120 million. The price of a ride is $ 1, and the price elasticity of demand for public transportation has been estimated to be - 0.4. By law, the public transportation authority must take steps to eliminate its operating defi cit. ( a) What pricing policy should the transportation authority adopt? Why? ( b) What price per ride must the public transportation authority charge to eliminate the defi cit if it cannot reduce costs?

(a) With an price inelastic demand an increase in price will cause revenue to rise. So they should increase the price.

Suggestion – increase the price of a ride from $1 to be $1.50, a 50% increase in price. Given the price elasticity of demand of -0.4, calculate the percentage change in the ride and the total new rides (the original rides are 100 million = $100 million/$1) using equation (4-7). Then use the total new rides time the new price of $1.50 to obtain the new total revenue

Following the above suggestion, and recalling , the percentage change in rides = -0.4*50% = -20%. Total rides fall by 20%. Given rides were 100 million, this means the new number of rides is 80 million. So multiplying the new rides by 1.50 we get

New Revenue = 80 million*1.5 = 120 million.

9. [5 points]
A researcher estimated that the price elasticity of demand for automobiles in the United States is - 1.2, while the income elasticity of demand is 3.0. Next year, U. S. automakers intend to increase the average price of automobiles by 5 percent, and they expect consumers’ disposable income to rise by 3 percent. ( a) If sales of domestically produced automobiles are 8 million this...
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