Question

1.    For each of the following pairs of goods, which good is expected to have the more price elastic demand?

[i]    Milk [all brands, grades] or President's Choice Cola [a generic brand of cola]

[ii]   Cell phone usage or matches

[iii] Restaurant meals or food [generally defined]

           [iv] Auto gas during the next 3 months or during the next 3 years

2.    In the United States in 1916, the Ford Motor Company sold 500,000 Model T fords at a price of $440. Henry Ford, the founder of the Ford Motor Company, believed he could increase sales of the Model T by 40,000 cars if he cut the price to $400.

[a] Use the provided information to calculate the anticipated price elasticity of demand [PED] for the Model T Ford.   

[b] Based on your calculation in [a], did Henry Ford believe demand for the Model T was elastic or inelastic?

[c]   Based on your calculation in [a], if Henry Ford wished to increase total revenue from Model T sales, should he have increased or decreased price?

3.     [a] A recent study found that the cross-price elasticity of demand for marijuana and beer is –

               0.63. In light of this result, are marijuana and beer complements or substitutes?

        [b] The income elasticities of demand for movies and clothing have been estimated to be +3.4

               and +0.5, respectively. What do the associated numerical values imply about the items?

4.    Which good do you expect would you expect to have a smaller price elasticity of supply in the short term – baby-sitting services or rental accommodation?

Answer 1

1.)

i. Presidents' Choice Cola

ii. Matches

iii. Restaurant Meals

2.)

i.

Price Elasticity of Demand is given by:

Therefore,

Initial Price (P1) = 440,

New Price (P2) = 400,

Initial Quantity (Q1) = 500000

New Quantity (Q2) = 540000.

PED = ( (540000 − 500000) / (540000 + 500000) / 2) / ( (400 - 440) / (400 + 440) / 2)

PED = 0.0192 / -0.0238

PED = -0.8077

ii.) He believed that the demand for model T was inelastic as |PED| = 0.807 < 1.

3.

i.) Since the cross-price elasticity of demand is positive, beer and marijuana are substitutes.

ii.) The two goods are normal goods since the value of YED is positive, and since the value is between 0 and 1 the goods are necessities.

4.

i.) Rental accommodations are likely to have smaller elasticity of supply as their supply cannot be highly responsive and sensitive to a change in their price in the short-run. Whereas babysitting services can be made more readily available if prices increase, and vice versa.