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Ch 5 : Problems and Applications

Ch 5 : Problems and Applications. 1. More Elastic? : A. Mystery novels or required text Mystery novels Have more close substitutes May be considered a luxury B. Beethoven or Classical Music Beethoven - more narrowly defined market – can find more close substitutes.

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Ch 5 : Problems and Applications

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  1. Ch 5 : Problems and Applications • 1. More Elastic? : • A. Mystery novels or required text • Mystery novels • Have more close substitutes • May be considered a luxury • B. Beethoven or Classical Music • Beethoven - more narrowly defined market – can find more close substitutes

  2. C. Heating Oil (over 5 years or 6 months) • Over 5 years – can adjust habits / find substitutes • D. Root Beer or Water • Root beer – may be considered luxury / can find more close substitutes

  3. 2. A. P up from $200 to $250 • Business travelers 1900 – 2000 / 2000 .05 5% $250 - $200 / 200 .25 25% PED = .2 = Inelastic Vacationers 600-800 / 800 .25 25% $250 - $200 / 200 .25 25% PED = 1 = unit elastic

  4. B. Vacationers PED is more elastic than business travelers because….. • Luxury vs. necessity • 3. at income of $10,000 P of CD up from $8 to $10 32-40 / 40 = .2 20% $10-$8/$8 = .25 25% = PED = .8 Inelastic

  5. When income is $12,000 45-50/50 = .10 10% $10-$8 / $8 = .25 25% = PED .4 inelastic • IED : Income up $10 k - $12 k when P = $12 30-24/24 = 25% $12k - $10k / $10k = 20% = IED + 1.25 Elastic, Normal

  6. IED Income up $10k to $12 k when P $16 12-8/8 50% $12k - $10k / $10k 20% IED = + 2.5 Elastic, Normal

  7. 4. A. Emily always spends 1/3 of income on clothing • If she always spends 1/3 of income …then any change in her income would result in an equal % change in her D…so IED….. = • 1 • B. PED? • For every 1% increase in P, then would be 1% change in D to maintain her 1/3 spending of income • PED = 1

  8. If change taste and now spends ¼ of income .....how does D curve change • D curve shifts left…at every P, D is now less • What is IED and PED now??? • Still 1

  9. 4 million fewer riders in Dec… a 4.3% decline After P increased 25 cents to $1.50 A. PED? 4.3% $1.50-$1.25 / $1.25 = 20% = PED .215 = inelastic B. What happens to revenue? If PED is inelastic and P increases = TR increases

  10. C. Why might PED estimate be unreliable ? • It has only been 1 month after P increase • As time passes, people may find alternatives and therefore it becomes More Elastic

  11. 6. Before looking at Price, Tom says I’d like 10 gallons of gas. • Toms PED = ? • 0 Perfectly Inelastic…explain • He will buy same Q (10 gal) no matter what the price • Jerry says I’d like $10 worth of gas • Jerry’s PED = ? • 1 unit elastic…explain • He will spend $10 no matter what the P is…if the P has risen, QD will fall at same ratio

  12. 7. spending on restaurant meals declines more during economic downturns than does spending on food to be eaten at home. Explain – • Econ downturns = decrease in income • Expect a decrease in income to result in a larger decrease in D for restaurants than a decrease in food at home • = Luxury vs. necessity

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