Question

e) Suppose that the video streaming service is charging the price that maximizes its total revenue, but the city government imposes an excise tax on videos that results in the price of videos rising to $3.50. As a result, the demand for movies increases by 20 at each price.

Price of Movies($)	(New) Number of movie-goers	Total Revenue ($)
2	420	840
3	380	1140
4	340	1360
5	300	1500
6	260	1560
7	220	1540
8	180	1440

g) Given the circumstances in (e), what is the cross elasticity of movies for videos? What does this say about the relationship between the two products? Round your answer to 2 decimal places.

Elasticity:    .

h) Referring to the original data in the table given below, assume now that the average weekly earnings of the townspeople rise from $700 to $800, with the result that the demand for movies increases by 10 percent. If the price being charged is $6, what is the income elasticity of demand? What does this suggest about the product, movies? Round your answer to 2 decimal places.

Price of Movies($)	Number of movie-goers	Total Revenue($)	Price of Videos($)	Quantity of Videos Demanded	Total Revenue($)
2	400	800	2.25	850	1912.5
3	360	1080	2.5	800	2000
4	320	1280	2.75	700	1925
5	280	1400	3	600	1800
6	240	1440	3.25	450	1462.5
7	200	1400	3.5	300	1050
8	160	1280	3.75	250	937.5

Elasticity:   .

Answer 1

Answer -

Suppose that the video streaming service is charging the price that maximizes its total revenue, but the city government imposes an excise tax on videos that results in the price of videos rising to $3.50. As a result, the demand for movies increases by 20 at each price.

Price of Movies($)	(New) Number of movie-goers	Total Revenue ($)
2	420	840
3	380	1140
4	340	1360
5	300	1500
6	260	1560
7	220	1540
8	180	1440

g) The cross-price elasticity of demand of movies for videos

= (% change in quantity demanded of movies) / (% change in price of videos)

Therefore, % change in quantity demanded of movies = (260 – 240)/(260+240)/2 * 100 = 8%

% change in price of videos = (3.50 – 2.50)/(3.50+2.50)/2 * 100 = 33%

Thus, the cross-price elasticity of demand of movies for videos

= 8%/33% = 0.24

So, the positive cross price elasticity between movies and videos implies that movies and videos are substitute goods. Thus, when the price of videos increases by 33%, people switch from videos to movies and thus the no. of movie goers increases by 8%.

(h) Average weekly earnings of the townspeople rise from $700 to $800.

So, the % increase in income = (800 – 700)/(800 + 700)/2 = 13.33%

As a result, the demand for movies increases by 10%.

The income elasticity of demand (YED)

= (% change in demand for movies)/(% change in income)

=13.33%/10%

=1.33 > 1.

The positive income elasticity of demand implies that movie is a normal goods. For normal goods, a rise in income will result in increase in quantity demanded. Now further we see that YED of movies is greater than 1, which means that movie is also a luxury good and not necessity.