Question

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1. (15 points) Suppose John, the owner-manager of a local hotel projects the following demand for his rooms:

                        Price ($)          Qty. Demanded

                        90                    100

                        110                  90

                        130                  70

                       

1. Calculate the price elasticity of demand between $90 and $110 using the midpoint formula
2. Is the price elasticity of demand elastic, inelastic, or unit elastic at this price range (re: a)? Interpret the actual number you calculated.
3. Is it a good idea for John to raise his price from $90 to $110? Explain in 2 sentences.
4. Calculate John’s total revenue when price is $110 vs. when price is $130.
5. Based on your answers in (d), is demand elastic, unit elastic or inelastic at that price range (re: d)?

2. Consider the two products – laundry soap and Tide washer soap. Which product will have the more inelastic demand? Explain in 2-3 sentences. (5 points)

3. TRUE or FALSE. Suppose the market for crude oil experiences a decrease in demand. Assuming a relatively inelastic supply for crude oil, this market shock leads to a relatively smaller decrease in equilibrium price. Include a graph to illustrate and explain in 2-3 sentences (5 points).

Answer 1

a) Elasticity of demand = {[Q₂ - Q₁] / [(Q₂ + Q₁) / 2]} / {[P₂ - P₁] / [(P₂ + P₁) / 2]}

= {(90 - 100) / [(90 + 100) / 2]} / {(110 - 90) / [(110 + 90) / 2]}

= (-10 / 95) / (20 / 100)

= (-10 / 95) x (100 / 20)

= -1000 / 1900 = -0.52 is the answer.

b) As the absolute value of elasticity of demand is less than 1, the demand is said to be inelastic which means that for a given change in price, the demand does not change by a very large amount.

c) Yes, it is a good idea to raise the price from $90 to $110 as the demand does not change by a very large amount or it does not decrease by a very large amount but the total revenue increases from $9000 to $9900. Percentage increase in price is more than the percentage change in quantity demanded.

d) Total Revenue when price is $110 = Price x Quantity demanded = 110 x 90 = 9900 is the answer.

Total Revenue when price is $130 = Price x Quantity demanded = 130 x 70 = 9100 is the answer.