6.8 PROBLEMS

Question 6.17

Nile.ca, the online bookseller, wants to increase its total revenue. One strategy is to offer a 10% discount on every book it sells. Nile.ca knows that its customers can be divided into two distinct groups according to their likely responses to the discount. The accompanying table shows how the two groups respond to the discount.

  1. Using the midpoint method, calculate the price elasticities of demand for group A and group B.

  2. Explain how the discount will affect total revenue from each group.

  3. Suppose Nile.ca knows which group each customer belongs to when he or she logs in and can choose whether or not to offer the 10% discount. If Nile.ca wants to increase its total revenue, should discounts be offered to group A or to group B, to neither group, or to both groups?

Question 6.18

Do you think the price elasticity of demand for Ford sport-utility vehicles (SUVs) will increase, decrease, or remain the same when each of the following events occurs? Explain your answer.

  1. Other car manufacturers, such as General Motors, decide to make and sell SUVs.

  2. SUVs produced in foreign countries are banned from the Canadian market.

  3. Due to ad campaigns, Canadians believe that SUVs are much safer than ordinary passenger cars.

  4. The time period over which you measure the elasticity lengthens. During that longer time, new models such as four-wheel-drive cargo vans appear.

Question 6.19

The following table shows the quantity of wheat flour demanded and the average price in Canada between 2011 and 2012.

  1. Using the midpoint method, calculate the price elasticity of demand for wheat flour.

  2. What is the total revenue for Canadian flour suppliers in 2011 and 2012?

  3. Did the price change increase or decrease the total revenue of Canadian flour suppliers? How could you have predicted this from your answer to part (a)?

Question 6.20

The accompanying table gives part of the supply schedule for personal computers in Canada.

  1. Calculate the price elasticity of supply when the price increases from $900 to $1100 using the midpoint method.

  2. Suppose firms produce 1000 more computers at any given price due to improved technology. As price increases from $900 to $1100, is the price elasticity of supply now greater than, less than, or the same as it was in part (a)?

  3. Suppose a longer time period under consideration means that the quantity supplied at any given price is 20% higher than the figures given in the table. As price increases from $900 to $1100, is the price elasticity of supply now greater than, less than, or the same as it was in part (a)?

Question 6.21

The accompanying table lists the cross-price elasticities of demand for several goods, where the percentage quantity change is measured for the first good of the pair, and the percentage price change is measured for the second good.

  1. Explain the sign of each of the cross-price elasticities. What does it imply about the relationship between the two goods in question?

  2. Compare the absolute values of the cross-price elasticities and explain their magnitudes. For example, why is the cross-price elasticity of McDonald’s burgers and Harvey’s burgers less than the cross-price elasticity of butter and margarine?

  3. Use the information in the table to calculate how a 5% increase in the price of Pepsi affects the quantity of Coke demanded.

  4. Use the information in the table to calculate how a 10% decrease in the price of gasoline affects the quantity of SUVs demanded.

Question 6.22

What can you conclude about the price elasticity of demand in each of the following statements?

  1. “The pizza delivery business in this town is very competitive. I’d lose half my customers if I raised the price by as little as 10%.”

  2. “I owned both of the two Jerry Garcia autographed lithographs in existence. I sold one on eBay for a high price. But when I sold the second one, the price dropped by 80%.”

  3. “My economics professor has chosen to use the Krugman, Wells, Au, and Parkinson textbook for this class. I have no choice but to buy this book.”

  4. “I always spend a total of exactly $10 per week on coffee.”

Question 6.23

Take a linear demand curve like the one shown in Figure 6-5, where the range of prices for which demand is elastic and inelastic is labelled. In each of the following scenarios, the supply curve shifts. Show along which portion of the demand curve (that is, the elastic or the inelastic portion) the supply curve must have shifted in order to generate the event described. In each case, show on the diagram the quantity effect and the price effect.

  1. Recent attempts by the Mexican army to stop the flow of illegal drugs into Canada have actually benefitted drug dealers.

  2. New construction increased the number of seats in the football stadium and resulted in greater total revenue from box-office ticket sales.

  3. A fall in input prices has led to higher output of Porsches. But total revenue for the Porsche Company has declined as a result.

Question 6.24

The accompanying table shows the price and yearly quantity sold of souvenir T-shirts in the town of Saint John according to the average income of the tourists visiting.

  1. Using the midpoint method, calculate the price elasticity of demand when the price of a T-shirt rises from $5 to $6 and the average tourist income is $20 000. Also calculate it when the average tourist income is $30 000.

  2. Using the midpoint method, calculate the income elasticity of demand when the price of a T-shirt is $4 and the average tourist income increases from $20 000 to $30 000. Also calculate it when the price is $7.

Question 6.25

A recent study determined the following elasticities for Volkswagen Beetles:

The supply of Beetles is elastic. Based on this information, are the following statements true or false? Explain your reasoning.

  1. A 10% increase in the price of a Beetle will reduce the quantity demanded by 20%.

  2. An increase in consumer income will increase the price and quantity of Beetles sold. Since price elasticity of demand is greater than 1, total revenue will go down.

Question 6.26

In each of the following cases, do you think the price elasticity of supply is (i) perfectly elastic; (ii) perfectly inelastic; (iii) elastic, but not perfectly elastic; or (iv) inelastic, but not perfectly inelastic? Explain using a diagram.

  1. An increase in demand this summer for luxury cruises leads to a huge jump in the sales price of a cabin on the Carnival Splendor.

  2. The price of a kilowatt of electricity is the same during periods of high electricity demand as during periods of low electricity demand.

  3. Fewer people want to fly during February than during any other month. The airlines cancel about 10% of their flights as ticket prices fall about 20% during this month.

  4. Owners of cottages on Prince Edward Island rent them out during the summer. Due to the soft economy this year, a 30% decline in the price of a vacation rental leads more than half of homeowners to occupy their vacation homes themselves during the summer.

Question 6.27

Use an elasticity concept to explain each of the following observations.

  1. During economic booms, the number of new personal care businesses, such as gyms and salons, is proportionately greater than the number of other new businesses, such as grocery stores.

  2. Cement is the primary building material in Mexico. After new technology makes cement cheaper to produce, the supply curve for the Mexican cement industry becomes relatively flatter.

  3. Some goods that were once considered luxuries, like a telephone, are now considered virtual necessities. As a result, the demand curve for telephone services has become steeper over time.

  4. Consumers in a less developed country like Guatemala spend proportionately more of their income on equipment for producing things at home, like sewing machines, than consumers in a more developed country like Canada.

Question 6.28

Taiwan is a major world supplier of semiconductor chips. A recent earthquake severely damaged the production facilities of Taiwanese chip-producing companies, sharply reducing the amount of chips they could produce.

  1. Assume that the total revenue of a typical non-Taiwanese chip manufacturer rises due to these events. In terms of an elasticity, what must be true for this to happen? Illustrate the change in total revenue with a diagram, indicating the price effect and the quantity effect of the Taiwan earthquake on this company’s total revenue.

  2. Now assume that the total revenue of a typical non-Taiwanese chip manufacturer falls due to these events. In terms of an elasticity, what must be true for this to happen? Illustrate the change in total revenue with a diagram, indicating the price effect and the quantity effect of the Taiwan earthquake on this company’s total revenue.

Question 6.29

There is a debate about whether sterile hypodermic needles should be passed out free of charge in cities with high drug use. Proponents argue that doing so will reduce the incidence of diseases, such as HIV/AIDS, that are often spread by needle sharing among drug users. Opponents believe that doing so will encourage more drug use by reducing the risks of this behaviour. As an economist asked to assess the policy, you must know the following: (i) how responsive the spread of diseases like HIV/AIDS is to the price of sterile needles and (ii) how responsive drug use is to the price of sterile needles. Assuming that you know these two things, use the concepts of price elasticity of demand for sterile needles and the cross-price elasticity between drugs and sterile needles to answer the following questions.

  1. In what circumstances do you believe this is a beneficial policy?

  2. In what circumstances do you believe this is a bad policy?

Question 6.30

Worldwide, the average coffee grower has increased the amount of land under cultivation over the past few years. The result has been that the average coffee plantation produces significantly more coffee than it did 10 to 20 years ago. Unfortunately for the growers, however, this has also been a period in which their total revenues have plunged. In terms of an elasticity, what must be true for these events to have occurred? Illustrate these events with a diagram, indicating the quantity effect and the price effect that gave rise to these events.

Question 6.31

Anindya Sen and May Luong studied the relationship between the price of beer and rates of sexually transmitted infections (STIs) in Canada. Their result indicated that there is a significant relationship between beer price and STI rates. Their findings suggest that “higher beer prices do result in lower STI rates and price elasticities within a range of –0.6 to –1.4.”4 According to this estimate of the cross-price elasticity of demand by Sen and Leong, are beer and STIs complements or substitutes? Explain.

Question 6.32

The U.S. government is considering reducing the amount of carbon dioxide that firms are allowed to produce by issuing a limited number of tradable allowances for carbon dioxide (CO2) emissions. In an April 25, 2007, report, the U.S. Congressional Budget Office (CBO) argues that “most of the cost of meeting a cap on CO2 emissions would be borne by consumers, who would face persistently higher prices for products such as electricity and gasoline … poorer households would bear a larger burden relative to their income than wealthier households would.” What assumption about one of the elasticities you learned about in this chapter has to be true for poorer households to be disproportionately affected?

Question 6.33

According to data from auto sales data website, Good Car Bad Car (www.goodcarbadcar.net), Canadian sales of the fuel-efficient Toyota Prius hybrid rose from 1581 vehicles sold in 2011 to 3371 in 2012. Over the same period, according to data from Natural Resources Canada, the average price of regular gasoline rose from $1.24 to $1.27 per litre. Using the midpoint method, calculate the cross-price elasticity of demand between Toyota Prii (the official plural of “Prius” is “Prii”) and regular gasoline. According to your estimate of the cross-price elasticity, are the two goods complements or substitutes? Does your answer make sense?