Question

In: Economics

A 10% increase in the price of pizza causes a 20% drop in the quantity of...

  1. A 10% increase in the price of pizza causes a 20% drop in the quantity of pizza purchased and a 10% drop in the quantity of beer sold. What can you say about the price elasticity of demand for pizza and the cross-price elasticity of demand between beer and pizza? Explain your answer and show your work. Discuss the nature of the two goods (pizza and beer).

  2. Rank these three items in terms of their price elasticity of the demand at any given price, from most elastic to least elastic: hot beverages in general, hot chocolate, and Starbuck’s hot chocolate. Explain your answer.

  3. Ben buys peanuts and soda. He has 2 cans of soda and 3 bags of peanuts. The marginal utility of the second can of soda is 20 units of utility and the marginal utility from the third bag of peanuts is 15. The price of soda is $1 and the price of peanuts is $2 per bag. Is Ben maximizing his utility? Why or why not? Explain your answer and show your work.

Only need help with question 2 and 3, Thanks a lot!

Solutions

Expert Solution


Question 2

Availability of substitutes impacts the elasticity of demand for a good.

If a good has many substitutes then it will have elastic demand and if a good has fewer substitutes then it will have inelastic demand.

Hot beverages in general do not have substitutes as they cannot be substituted with something hot that can be drink. If there is anything like that it would be termed as hot beverage.

So, hot beverages in general, do not have any substitute and thus have least elastic demand.

Hot chocolates has substitute like ginger tea or hot lemon water etc. Thus, demand for hot chocolate is elastic.

Starbucks's hot chocolate has most number of perfect substitutes in terms of hot chocolates served by other fast food restaurants like Dunkin Donuts, McDonald's, Caribou Coffee Shop etc. Thus, demand for it is most elastic.

Following is the required table -

Item Elasticity of demand
Starbucks Hot Chocolate Most elastic
Hot Chocolate Elastic
Hot beverages in general Least elastic

Question 3

An individual consumer consuming two goods, say X and Y, maximizes utility when following condition is fulfilled -

MUX/PX = MUY/PY

Marginal utility of second can of soda is 20.

Price of soda = $1

MUs/Ps = 20/1 = 20

Marginal utility of 3rd bag of peanuts = 15

Price of peanuts = $2

MUp/Pp = 15/2 = 7.5

It can be seen that,

MUs/Ps > MUp/Pp

So,

Ben is not maximizing his utility.

He must decrease his consumption of peanut and increase his consumption of soda.

This should remain continue till ratio of marginal utility and price of both goods becomes equal as then Ben would be maximizing his utility.


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