Question

1. Suppose that a large public university is experiencing a budget shortfall. They decide to increase tuition to try to make up for the difference. Last year (2017) the school charged out-of-state tuition of $18,000 and instate tuition of $8,000. The enrollment numbers for 2017 were 5,000 out-of-state students and 12,000 instate students. During the 2018 academic year tuition for out-of-state students increased to $20,000, and for in-state it increased to $9,000. The enrollment for 2018 dropped to 4,000 out-of-state and 11,000 instate students. a. (3 points) Calculate the price elasticity of demand for out-of-state students. Then calculate the price elasticity of demand for in-state students. (Round to 3 decimal places).

b. (2 points) Based on part a, how would you characterize demand for each group of students? Explain whether these results are what you would predict for this situation.

c. (2 point) Did this university make the right decision by raising each tuition rate? How could the administration use this information to maximize revenue?

Answer 1

(a) Using mid-point method, Elasticity = (Change in quantity / Average quantity) / (Change in price / Average price)

For Out-of state,

Elasticity = [(4,000 - 5,000) / (4,000 + 5,000)] / [(20,000 - 18,000) / (20,000 + 18,000)]

= (-1,000 / 9,000) / (2,000 / 38,000)

= -2.111

For In-state,

Elasticity = [(11,000 - 12,000) / (11,000 + 12,000)] / [(9,000 - 8,000) / (9,000 + 8,000)]

= (-1,000 / 23,000) / (1,000 / 17,000)

= -0.739

(b)

Since absolute value of elasticity is higher than 1 for out-of-state, demand is elastic in this segment. Since absolute value of elasticity is lower than 1 for in-state, demand is inelastic in this segment. This is expected, since out-of-state students have many other out-of-state colleges to choose as substitutes, so their demand is elastic, but in-state students are location-bound and have less number of substitutes available, so their demand is inelastic.

(c)

In inelastic market, a rise in price increases revenue, so increasing price in in-state segment was correct decision. But in elastic market, a rise in price decreases revenue, so increasing price in out-of--state segment was incorrect decision. Instead tuition fees should have been decreased in this segment in order to increase revenue.