Economics 2306 Name ___________________
Principles of Microeconomics
Professor James Henderson
Spring 1998
Homework No. 3: Concepts in Elasticity
1. Suppose the university collects the following information on illegal parking and the size of fines on the typical college campus.
<table><pre>
Price of a Tickets issued Total daily Price elasticity
parking ticket per day revenue of demand
10 100
20 80
30 60
40 40
50 20
</table></pre>
a. Calculate the revenue and price elasticity of demand for each price-quantity combination. Record in the spaces provided. At what point does the demand change from elastic to inelastic? ___________________
b. Given this information, what pricing policy would you recommend the university follow on the size of parking fines? _________________________________________________________________________
2. Assume that the demand for a particular product is determined to be perfectly elastic. How will the price change as the supply curve shifts? _______________________ Why? ____________________________
How does total revenue change as the supply curve shifts? ______________________________________
Show this on the graph below.
3. Consider the following quote from the July 8, 1993 Wall Street Journal: "A bumper crop of oranges in Florida last year drove down orange prices. As juice marketers' cost fell, they cut prices by as much as 15%. That was enough to tempt some value-oriented customers: unit volume of frozen juices actually rose by about 6% during the most recent quarter." Given these numbers, and assuming there were no changes in demand shifters (no change in ceteris paribus conditions) for frozen orange juice, what was the price elasticity of demand for frozen orange juice? What do you think happened to total spending on frozen orange juice? Why?
4. Calculate the cross-price elasticity of demand for the following situations. Are the two goods in question complements of substitutes?
a. The price of movie theater tickets goes up by 10 percent, causing the quantity demanded for video rentals to go up by 4 percent.
b. The price of computers falls by 20 percent, causing the quantity demanded of software to increase by 15 percent.
c. The price of apples falls by 5 percent, causing the quantity demanded of pears to fall by 5 percent.
d. The price of ice cream falls by 6 percent, causing the quantity demanded of frozen yogurt to fall by 1 percent.
5. Given the following income elasticities of demand, would you classify the following goods as normal or inferior goods?
a. Potatoes: income elasticity of 0.5. ____________________
b. Pinto beans: income elasticity of -0.1 __________________
c. Bottled water: income elasticity of 1.1 _________________
d. Video cameras: income elasticity of 1.4 ________________
6. The price elasticity of demand for medical care has been estimated to be -0.2. Characterize this demand as elastic, unit elastic, or inelastic. ________________ We normally expect that the greater the importance of an item in the consumer's budget, the greater the price elasticity. Medical care costs account for a substantial share of the typical consumer's budget. Why is the price elasticity for medical care so low?
7. Suppose the price elasticity of demand for wheat is -0.7 and that farmers have an unusually good year--the wheat harvest is at record levels. What will happen to the total revenues received by wheat farmers? Explain.
8. Suppose the demand for cigarettes is very inelastic. If the government imposes a tax per pack of cigarettes, it is equivalent to the supply curve shifting up vertically by the amount of the tax. Show this on the diagram below. If the demand for cigarettes is perfectly inelastic, by how much does the price per pack of cigarettes increase? Explain. What is the economic lesson to be learned about "sin" taxes?