Supply and Demand and Price

Topics: Supply and demand, Price elasticity of demand, Elasticity Pages: 7 (1041 words) Published: September 7, 2009

Managerial Economics

Lecturer : Dr. Lai Yew Wah

Tutorial 3 solutions

Group 5

Chan Wooi Wang ( S-GSM0028/09 )

Chu Wee Liang ( S-GSM0039/09 )

Lee Yee Ling ( S-GSM0087/09 )


Q 5. What would you expect to happen to spending on food at home and spending on food restaurants during a decline a decline in economic activity ? How would income elasticity of demand help explain these things ?

Q ( Demand )

QS0 Superior




Y1Y0Y ( Income )

During the decline in economy activity, the spending power will decrease which is similar as the decline in income. Home food which is economical are inferior goods while restaurant food which is much more costly are superior goods. Therefore from the income elasticity of demand curve, the demand for home food will increase from QI0 to QI1 while the demand for restaurant food will decrease from QS0 to QS1 when the income decreases from Y0 to Y1.

Q9.The immediate effect of gasoline price increases in the aftermath of the Persian Gulf crisis in August 1990 on gasoline consumption was not very significant. Would you expect the consumption of gasoline to be more severely affected if these higher prices remained in effect for a year or more ? Why or why not ?

Based on the law of demand define the typical relationship between the price and quantity demands.

Consumer would tend to purchase more when the price is low and lesser when the price of gasoline is high. When the price of gasoline is increases consumers would find their way to adjust to the price.

A factor to determine the demand elasticity is ease to find the substitution. As for this case there is only little substitution for the gasoline in the short run. Since there is less substitution for gasoline hence it would be considered is inelastic elasticity in short run

As for the long run, when the price of gasoline increase the demand of elasticity would be more elastic as the consumer can adapt the over the increase of the price for gasoline.

Instead of driving the consumer can take public transport when they go to work. Consumer need some time to make the necessary changes. This could happen in long run as this involve changing of habit or lifestyle of consumer.

Q 11. Why do you think that whenever governments ( federal and state ) want to increase revenues, they usually propose an increase in taxes on cigarettes and alcohol ?

Cigarettes and alcohol are both addictive goods and they are not easy to get rid off. Therefore, these are inelastic products where changes in price will not give a large impact on the quantity consumed by the consumers. Hence, the total revenue for the government will still increase even if the government increases the taxes for cigarettes and alcohol.

Problems :

Q7. The ABC company manufactures AM/FM clock radios and sells on average 3,000 units monthly at $25 each to retail stores. Its closest competitor produces similar type of radio that sells for $28.

a. If demand for ABC's product has an elasticity coefficient of -3,how many will it sell per month if the price is lowered to $22 ?

From the arc elasticity of demand equation,

Ep = Q2- Q1 / P2 - P1
(Q1 + Q2 ) /2 ( P1 + P2 ) / 2

-3 = Q2- 3,000 / $22 - $25
(3,000 + Q2 ) /2 ( $25 + $22 ) / 2

Q2= 4,421 units

Therefore, by lowering the price to $22, ABC company will be able to sell 4,421 units.

b. The competitor decreases its price to $24. If cross-elasticity between the two radios is 0.3, what will ABC's monthly sales be ?

Therefore, when the competitor price is lowered to $24,

Ex = Q2a- Q1a / P2b - P1b
(Q1a + Q2a ) /2 ( P1b + P2b ) / 2

0.3 = Qabc- 3,000 / $24 - $28
(3,000 + Qabc ) /2 ( $28 +...
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