Econ 1 TA session Chapter 5 Question 2 Week 3 Suppose that business travelers and vacationers have the following demand for airline tickets from New York to Boston Quantity Demanded Quantity Demanded business travelers vacationers 2 100 tickets 1 000 tickets Price 150 200 250 300 2 000 1 900 1 800 800 600 400 a As the price of tickets rises from 200 to 250 what is the price elasticity of demand for i business travelers and ii vacationers Use the midpoint method in your calculations b Why might vacationers have a different elasticity from business travelers Solution a For business travelers the price elasticity of demand when the price of tickets rises from 200 to 250 is 2 000 1 900 1 950 250 200 225 0 05 0 22 0 23 For vaca tioners the price elasticity of demand when the price of tickets rises from 200 to 250 is 800 600 700 250 200 225 0 29 0 22 1 32 b The price elasticity of demand for vacationers is higher than the elasticity for business travelers because vacationers can choose more easily a different mode of transportation like driving or taking the train Business travelers are less likely to do so because time is more important to them and their schedules are less adaptable 1 Week 3 Econ 1 TA session Question 5 of coffee Solution Cups of coffee and donuts are complements Both have inelastic demand A hurricane destroys half the coffee bean crop Use appropriately labeled diagrams to answer the following questions a What happens to the price of coffee beans b What happens to the price of a cup of coffee What happens to total expenditure on cups c What happens to the price of donuts What happens to total expenditure on donuts a Since coffee beans become more scarce we expect the price of coffee beans to increase b With an increase in the price of beans the supply curve for coffee cups shifts left at a given price producers are willing to offer less quantity See Figure 1 Then the price of coffee cups increases and quantity falls Expenditure is P Q but P and Q move in different directions so it is not apparent what happens with expenditure But since there was a shift in supply we are moving along the demand curve And we know demand is inelastic so quantities change less than prices and then we conclude that expenditure increases 2 Econ 1 TA session Week 3 Figure 1 c Since donuts and coffee cups are complements the demand for donuts shifts left and so equilibrium price falls Since the quantity also falls we conclude that expenditure falls 3 Econ 1 TA session Question 8 Week 3 The New York Times reported Feb 17 1996 that subway ridership declined after a fare increase There were nearly four million fewer riders in December 1995 the first full month after the price of a token increased 25 cents to 1 50 than in the previous December a 4 3 percent decline a Use these data to estimate the price elasticity of demand for subway rides b According to your estimate what happens to the Transit Authority s revenue when the c Why might your estimate of the elasticity be unreliable fare rises Solution a If quantity demanded falls by 4 3 when price rises by 20 the price elasticity of demand is 4 3 20 0 215 which is fairly inelastic b Because the demand is inelastic the Transit Authority s revenue rises when the fare rises c The elasticity estimate might be unreliable because it is only the first month after the fare increase As time goes by people may switch to other means of transportation in response to the price increase So the elasticity may be larger in the long run than it is in the short run 4 Econ 1 TA session Question 10 Consider public policy aimed at smoking Week 3 a Studies indicate that the price elasticity of demand for cigarettes is about 0 4 If a pack of cigarettes currently costs 5 and the government wants to reduce smoking by 20 percent by how much should it increase the price b If the government permanently increases the price of cigarettes will the policy have a larger effect on smoking 1 year from now or 5 years from now c Studies also find that teenagers have a higher price elasticity of demand than adults Why might this be true Solution a With a price elasticity of demand of 0 4 reducing the quantity demanded of cigarettes by 20 requires a 50 increase in price because 20 50 0 4 With the price of cigarettes currently 2 this would require an increase in the price to 3 33 a pack using the midpoint method note that 3 33 2 2 67 50 b The policy will have a larger effect five years from now than it does one year from now The elasticity is larger in the long run because it may take some time for people to reduce their cigarette usage The habit of smoking is hard to break in the short run c Because teenagers do not have as much income as adults they are likely to have a higher price elasticity of demand Also adults are more likely to be addicted to cigarettes making it more difficult to reduce their quantity demanded in response to a higher price 5