Question

The Reliable Aircraft Company manufactures small, pleasure-use aircraft. Based on past experience, sales volume appears to be affected by changes in the price of the planes and by the state of the economy as measured by consumers' disposable personal income. The following data pertaining to Reliable's aircraft sales, selling prices, and consumers' personal income were collected:

Year	Aircraft Sales	Average Price	Disposable Constant Income
		(Dollars)	(In constant 2006 dollars, billions)
2006	525	17,600	610
2007	450	8,000	610
2008	400	8,000	570

The arc price elasticity of demand between 2006 and 2007 is:

–0.36

0.21

0

0.36

Points:

Close Explanation

Explanation:

The arc income elasticity of demand between 2007 and 2008 is:

1.74

3.99

–3.99

0

Points:

Close Explanation

Explanation:

Assume that these estimates are expected to remain stable during 2009. Forecast 2009 sales for Reliable assuming that its aircraft prices remain constant at 2007 levels and that disposable personal income will increase by 7%. Also assume that the arc income elasticity you just computed is the best available estimate of income elasticity.

Aircraft Sales 2009 Forecast: selector 1

• 505
• 351
• 589
• 449
• 512

Points:

Close Explanation

Explanation:

Forecast 2009 sales for Reliable given that its aircraft prices will increase by 6% from 2008 levels and that disposable personal income will increase by 7%. Assume that the price and income effects are independent and additive and that the arc income and price elasticities you just computed are the best available estimates of these elasticities to be used in making the forecast.

Aircraft Sales 2009 Forecast: selector 1   

Answer 1

The arc price elasticity of demand between 2006 and 2007 is = (Change in demand / average demand) ÷ (change in price / average price) =

The arc income elasticity of demand between 2007 and 2008 is = (Change in demand / average demand) ÷ (change in income / average income) =

Assume that these estimates are expected to remain stable during 2009. Forecast 2009 sales for Reliable assuming that its aircraft prices remain constant at 2007 levels and that disposable personal income will increase by 7%. Also assume that the arc income elasticity you just computed is the best available estimate of income elasticity.

Income level in 2009 = 570 x (1 + 7%) =  610

(change in income / average income) = (610 - 570) / [(610 + 570) / 2] =  0.06763

(Change in demand / average demand) = (change in income / average income) x income elasticity of demand = 0.06763 x 1.74 =  0.117363

Let S be the sales in 2009 then,

(S - 400) / [(S + 400) / 2 ] = 0.117363

Or, (S - 400) / (S + 400) = 0.117363 / 2 =  0.05868

Hence, S = (1 + 0.05868) x 400 / (1 - 0.05868) = 449

Forecast 2009 sales for Reliable given that its aircraft prices will increase by 6% from 2008 levels and that disposable personal income will increase by 7%. Assume that the price and income effects are independent and additive and that the arc income and price elasticities you just computed are the best available estimates of these elasticities to be used in making the forecast.

Price level in 2009 = 8,000 x (1 + 6%) = 8,480

(change in price / average price) = (8,480 - 8,000) / [(8,480 + 8,000) / 2] = 0.0583

(Change in demand / average demand) = (change in price / average price) x price elasticity of demand = 0.0583 x 0.21 =   0.011949

Let S be the sales in 2009 then,

(S - 400) / [(S + 400) / 2 ] = 0.011949

Or, (S - 400) / (S + 400) = 0.011949 / 2 =   0.00597

Hence, S = (1 + 0.00597) x 400 / (1 - 0.00597) = 405