Running head: CRITICAL THINKING 2
Critical Thinking 2
Ben Yellets
Liberty University
Global Economic Environment
BUSI 620
Dr. Duda
March 28, 2014
1
CRITICAL THINKING 22
DQ. 4 -8. 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?
Since E = %∆Q \ %∆P, then %∆Q = E * %∆P
a)Elasticity of natural gas is 1.40 and 2.10 in the short and long run
%∆Q = E * %∆P = 1.40 * 10% = 14% in the short run
%∆Q = E * %∆P = 2.10 * 10% = 21% in the long run
b)Elasticity of electricity is 0.13 and 1.89 in the short and long run
%∆Q = E * %∆P = 0.13 * 10% = 1.3% in the short run
%∆Q = E * %∆P = 1.89 * 10% = 18.9% in the long run
DQ. 4 – 10. Agricultural commodities are known to have a price-inelastic demand and to
be necessities. How can this information allow us to explain why the income of farmers
falls (a) after a good harvest? (b) In relation to the incomes in other sectors of the
economy?
a)Price-inelastic demand means that a large proportional increase in the price will result in
a small proportional drop in quantity demanded, and vise versa. A good harvest will
increase the quantity of agricultural commodities, but the inelasticity means that even a
small increase in quantity will be cause a huge decrease in price. Total revenue will be
decreased because TR=P*Q.
b)The income in other sectors of economy increases and demand for agricultural
commodities increases. However, as the demand is price-inelastic, the largely increased
demand will only increase the price a little bit and therefore, farmer’s revenue is not
increased.
P 4-3. Starting with the estimated demand function for Chevrolets given Problem 2,
assume that the average value of the independent variables changes to N = 225 million, I =
CRITICAL THINKING 23 $12,000, Pғ = $10,000, Pᴳ = 100 cents, A = $250,000 And P¹ = 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, and on the same graph, plot the demand curve for Chevrolets, D,
found in Problem 2(d).
P 4-7. 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 deficit. (a) What
pricing policy should the transportation authority adopt? (b) What price per ride must the
public transportation authority charge to eliminate the defict if it cannot reduce costs?
Total Revenue = 100 million
Total Costs = 120 million
Price = $1.00
Elasticity = -0.4
Since the absolute value of the elasticity is less than 1, the demand is inelastic. A large
increase
in price will result in a small drop in quantity demanded. Then the price of per ride can be
increased without lowering its revenue.
So Total Revenue would be
TR = P + Q
The total differential gives:
d TR/TR = dP/P + dQ/Q
%∆TR = %∆P + %∆Q
The elasticity shows that %∆Q = -0.4 %∆P, we want the TR rises from 100 to 120 to cover
the
costs. So, %∆TR = 120/100 -1 = 0.2
0.2 = %∆P + (-0.4%∆P)
CRITICAL THINKING 24 0.2 = 0.6%∆p
%∆P = 1/3 = 0.00
So, the price should increase to $1.33
P 4-9. 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 year, how many automobiles do you expect U.S.
automakers to sell next year? (b) By how much should domestic automakers increase the
price of automobiles if they wish to increase sales by 5 percent next year?
E = -1.2
ῃ = %∆Q/ %∆Y = 3
%∆P = 5%
%∆Y = 3%
a)The overall change in sales is the sum of changes from price and from income:
%∆Q = E * %∆P + ῃ * %∆Y = -1.2 * 5% + 3.0 * 3% = -6% + 9% = 3%
Sales will increase by 3% in volume
b)If they want to increase number of sales by 5%, they cannot increase price that much:
%∆Q = E * %∆P + ῃ * %∆Y = 5%
-1.2 * %∆P + 3.0 * 3% = 5%
1.2 %∆P = 4 %
%∆P = 3.33%
CRITICAL THINKING 25 P 4-14. Suppose that a firm maximizes its total profits and has a
marginal cost(MC) of
production of $8 and the price elasticity of demand for the product it sells is (-)3. Find the
price at which the firm sells the product.
(P-MC)/P=1/e
(P-8)/P =1/-3
P=$7.67
P 5-8 In a study published in 1980, B.B. Gibson estimated the following price and income
elasticities of demand for six types of public goods: (a) Do these public goods conform to
the law of demand? For which public goods is demand price elastic? (b) What types of
goods are these public goods? (c) If the price or cost of college and university education
increased by 10 percent and, at the same time, incomes also increased by 10 percent, what
would be the change in the demand for college and university education?
P 5-15 Starting with data for Problem 6 and the data on the price of a relative commodity
for the years 1986 to 2005 given below, we estimated the regression for the quantity
demanded of a commodity (which we now relabel Qx), on the price of the
commodity(which we now label Px), consumer income (which we now label Y), and the
price of the related commodity (Pz), and we obtained the following results. (f you can, run
this regression yourself; you should get results identical or very similar to those given
below.) (b) Evaluate the above regression results. (c) What type of commodity is Z? Can
you be sure?
(b)
Froeb
6-1 George has been selling 5,000 T-shirts per month for $8.50. When he increased the
price to $9.50 he sold only 4,000 T-shirts. What is the demand elasticity? If his marginal
CRITICAL THINKING 26 cost is $4 per shirt, what is his desired markup and what is this
initial actual markup? Was
raising the price profitable?
6-3 To conduct an experiment, AMC increased move ticket prices form$9.00 to $10.00 and
measure the change in ticket sales. Using the data over the following month, they
concluded that the increase was profitable. However, over the subsequent months, they
changed their minds and discontinued the experiment. How did the timing affect their
conclusion about the profitability of increasing prices?
6-5 An end-of-aisle price promotions changes the price elasticity of a good from -2 to -3. If
the normal price is $10, what should the promotional price be?
