Answer:
1. Calculate the income elasticities of demand for the following:
A. Income rises by 20%; demand increases by 10%.
income elasticity of demand = % change in quantity demanded / % change in income
- income elasticity of demand = 10% / 20% = 0.5, normal good
B. Income rises from $30,000 to $40,000; demand increases (at a constant price) from 16 to 19.
- income elasticity of demand = 18.75% / 33.33% = 0.56, normal good
2. For each of the following pairs of goods, state whether the cross-price elasticity is likely positive, negative, or zero. Explain.
- complementary goods have a negative cross price elasticity, while substitute goods have a positive cross price elasticity.
A. Pen, pencil.
- Positive. They are close substitutes.
B. Ketchup, hot dogs.
- Negative. They are complements.
C. Tortillas, lobster tail.
- Negative. They are complements.
D. Home heating oil, natural gas.
- Positive. They are close substitutes.
3 and 8. One football season Domino’s Pizza, a corporate sponsor of the Washington Redskins (a football team), offered to reduce the price of its $8 medium-size pizza by $1 for every touchdown scored by the Redskins during the previous week. Until that year, the Redskins weren’t scoring many touchdowns. Much to the surprise of Domino’s, in one week in 1999, the Redskins scored 1 touchdown. (Maybe they like pizza.) Domino’s pizzas were selling for $7 a pie! The quantity of pizzas demanded soared the following week from 50 pies an hour to 60 pies an hour. What was price elasticity of demand for Domino’s pizza?
- price elasticity of demand = % change in quantity demanded / % change in price = 20% / -12.5% = -1.6 or |1.6| in absolute terms, price elastic
4. When tolls on the Dulles Airport Greenway were reduced from $2.00 to $0.75, traffic increased from 12,000 to 34,000 trips a day. Assuming all changes in quantity were due to the change in price, what is the price elasticity of demand for the Dulles Airport Greenway?
- price elasticity of demand = % change in quantity demanded / % change in price = 183.33% / -62.5% = -2.93 or |2.93| in absolute terms, price elastic
5. Determine the price elasticity of demand if, in response to an increase in price of 20%, quantity demanded decreases by 25%.
- price elasticity of demand = % change in quantity demanded / % change in price = -25% / 20% = -1.25 or |1.25| in absolute terms, price elastic
6. When the price of ketchup falls by 17%, the demand for hot dogs rises by 4%
- cross price elasticity of demand = % change in quantity demanded of good A / % change of price of good B = 4% / -17% = -0.24, complements
C. In the original scenario, what would have to happen to the demand for hot dogs for us to conclude that hot dogs and ketchup are substitutes?
- 1. The demand for hot dogs would have to decline.
The cross price elasticity of demand for substitute goods is positive (-/- = +)
7. Calculate the income elasticities of demand for the following:
A. Income rises by 5%; demand increases by 5%.
- income elasticity of demand = % change in quantity demanded / % change in income = 5% / 5% = 1, normal goods
b. Income rises from $75,000 to $90,000; demand increases (at a constant price) from 50 to 55.
- income elasticity of demand = 10% / 20% = 0.5, normal good
