Question

3. Here are some sample demand elasticity estimates for various goods:

1

st

class plane ticket = -.3

Regular plane ticket = -1.5

Soda = -.8

Coca-Cola = -3.8

A) Provide some rationale for why the two types of plane tickets have different elasticities.

B) Provide some rationale for why the elasticity of soda is lower than Coca-Cola.

C) If the price of all plane tickets rises, indicate what would happen to the revenue generated from

first class tickets versus regular tickets.

D) Would you expect the cross price elasticity between soda and water to be positive or negative?

Explain.

E) Would you expect the income elasticity on 1

st

class plane tickets to be positive or negative?

Explain.

F) If the price of Coca Cola rises from $1 to $1.5, how much would you expect quantity to change?

Your answer should be in %.

Answer 1

a) The two types of plane tickets have different elasticities . First class tickets are usually bought by the business travellers and thus are less sensitive to the change in demand because they value time higher in monetary terms than other passengers. Hence the willingness to substitute monetary for time advantages may be higher than expected for first class than regular class (leisure) travellers.

Regular class (leisure) travellers plan the trip as a whole , so they give more importance to the cost of tickets and hence are more sensitive to price changes.

b) The elasticity of coca cola is higher than soda because of presence of close substitutes. Coca cola is a soft drink having substitutes like pepsi etc , so has a higher elasticity.

c) The revenue generated from first class tickets would be decreased by 0.3% ( which is the elasticity , because change in revenue would be the product of change in qunatity and change in price )

The revenue generated from first class tickets would be decreased by 1.5% ( which is the elasticity , because change in revenue would be the product of change in qunatity and change in price )

So the revenue of regular tickets reduces more than first class tickets.

d) If an individual assumes water and soda to be substitutes , then the cross price elasticity would be positive: more the price of water more wouild be the demand of soda.

But if it is the case of compliments , the elasticity would be negative. more the price of water less wouild be the demand of soda.

e) Income elasticity of first class plane tickets is the % change in quantity of plane tickets when income changes . A positive change in income would mean that an individual is able to spend more , so the proportion to spend on the plane tickets would increase and vice versa. Hence the income elasticity is positive. If the prices of all plane tickets rise, keeping the income same , it means that the demand for first class tickets would be reduced more as compared to demand for regular tickets

f) The formula for elasticity of demand of Coca cola is given by

% change in quantity/ %change in price = -3.8

The percentage change in price is given by change in price / original price = (0.5/1)*100= 50%

Putting it in the formula

%change in quantity demanded = 50%*(3.8)= 190%

SO quantity demanded reduces by 190% when price increases by 50%.

(You can comment for doubts )