Deck 19: Demand and Supply Elasticity

Question 1

Explaining a Higher Price Elasticity of Demand for "Smokes"
Vivien Azer, a tobacco industry analyst at Citibank, smoked traditional cigarettes for more than 20 years. Now, however, she has switched entirely to e-cigarette devices. Along with other Citibank analysts, Azer has completed a report that has provided a new estimate of the longrun price elasticity of demand for traditional cigarettes. A decade ago, the value of this elasticity ranged between 0.3 and 0.4. Azer and her report co-authors have found the current value has more than doubled, to 0.8.
Based on her own experience, Azer knows why the price elasticity of demand is greater. There are now dozens of producers of e-cigarette devices that transmit the nicotine and other typical components of traditional cigarettes via a vapor rather than via tar- and toxin-laden smoke. Because studies have shown that e-cigarettes are less harmful than traditional cigarettes, the demand for e-cigarettes is growing rapidly. Thus, e-cigarettes have emerged as a viable substitute for traditional cigarettes. People can also use flavor cartridges to alter the taste of e-cigarette-generated vapors, which further widens the range of substitution. Now that traditional cigarettes are confronted with these e-cigarette substitute products, the demand for traditional cigarettes has become less inelastic.
As increased taxes on traditional cigarettes have pushed up their market-clearing prices, is the quantity of traditional cigarettes demanded more or less responsive to price changes than it was a decade ago? Explain.

Answer 1

Traditional cigarettes are facing stiff competition from e-cigarettes and hence, its demand has become more responsive to change in its price, at least in the last decade or so. This implies that the demand for traditional cigarettes is becoming elastic.A decade ago, e-cigarettes were not a cult. Hence, people did not have a choice. Hence, the demand for traditional cigarettes was inelastic. As taxes are increased on traditional cigarettes from time to time, the demand is becoming more and more responsive to any change in its price

Question 2

The Demand for First Class Mail Is Not Elastic
Based on what you have learned in this chapter, you might be tempted to jump to the conclusion that the problem faced by the USPS is an elastic demand for its first class mail services. After all, other things being equal, when the change in the amount of an item demanded exceeds the proportionate change in the item's own price, demand is elastic. Furthermore, total revenues decline in response to an increase in an item's price when the demand for the item is elastic.
In fact, study after study of the demand for first class mail concludes that the demand for this USPS service is inelastic. Recent estimates of the price elasticity of demand for first class mail range from as low as less than 0.1 to about 0.8-with most of those estimates closer to 0.1. Thus, the price elasticity of demand for first class mail is not the key explanation for decreases in USPS total revenues from its first class mail services.
The Key USPS Problem: Other Things Have Not Been Equal
Whenever we calculate the price elasticity of demand for an item, we typically assume that all other things than the price of the item and quantity of that item demanded are unchanged. In fact, this assumption has not held true for USPS first class mail since the beginning of this century. Other things were not equal during this period.
The main change that occurred after the earlY ₂000s was the growing utilization of digital devices, together with new telecommunications technologies. At first, people primarily used personal computers to communicate via e-mail. More recently they have utilized tablet devices and smartphones to communicate at no explicit price via e-mail, text messages, and social media. Economists cannot readily estimate the cross price elasticity of demand for USPS first class mail in relation to e-mail and text communications but have estimated the elasticity of demand for USPS first class mail with respect to ownership of digital devices. The elasticity estimates they have obtained indicate that since the earlY ₂000s, increased ownership of digital devices has reduced the demand for USPS first class mail services by more than 30 percent.
The crux of the USPS revenue problem has not been that its prices for first class mail services have increased too much. The difficulty has been that the demand curve for first class mail has shifted leftward considerably over time. Total revenues from first class mail have been decreasing because most people have substituted away from first class mail to digital communications.
Why is it important to keep in mind that relating a proportionate change in the quantity of an item to a proportionate change in that item's price yields the price elasticity of demand only when all other things are equal?

Answer 2

Elasticity of demand is determined by many factors, in addition to the price of a product alone. If one or all factors experiences a change, it influences the elasticity of that product. These factors include the availability of close substitutes, income of the consumer and the presence of substitutes or complements. They affect the demand for a product, besides its own price.
In case of Postal Services, the demand has been gradually falling owing to the availability of close substitutes such as e-mail, SMS, and other digital communication services. In such a scenario, merely computing the proportionate change in the quantity of Postal Services relative to a proportionate change in its own price will not yield the true price elasticity of demand for USPS. Because other factors, which were assumed to be constant, are changing rapidly, they must be taken care of.

Question 3

When the price of shirts emblazoned with a college logo is $20, consumers buY ₁50 per week. When the price declines to $19, consumers purchase 200 per week. Based on this information, calculate the price elasticity of demand for logoemblazoned shirts.

Answer 3

Original price of logo-emblazoned shirts = $20 per shirt
Original quantity demanded logo-emblazoned shirts = 150 per week
New price of logo-emblazoned shirts = $19 per shirt
New quantity demanded logo-emblazoned shirts = 200 per week
Calculating the price elasticity of demand for logo-emblazoned shirts - The price elasticity of demand for logo-emblazoned shirts is 5.57.

Question 4

Explaining a Higher Price Elasticity of Demand for "Smokes"
Vivien Azer, a tobacco industry analyst at Citibank, smoked traditional cigarettes for more than 20 years. Now, however, she has switched entirely to e-cigarette devices. Along with other Citibank analysts, Azer has completed a report that has provided a new estimate of the longrun price elasticity of demand for traditional cigarettes. A decade ago, the value of this elasticity ranged between 0.3 and 0.4. Azer and her report co-authors have found the current value has more than doubled, to 0.8.
Based on her own experience, Azer knows why the price elasticity of demand is greater. There are now dozens of producers of e-cigarette devices that transmit the nicotine and other typical components of traditional cigarettes via a vapor rather than via tar- and toxin-laden smoke. Because studies have shown that e-cigarettes are less harmful than traditional cigarettes, the demand for e-cigarettes is growing rapidly. Thus, e-cigarettes have emerged as a viable substitute for traditional cigarettes. People can also use flavor cartridges to alter the taste of e-cigarette-generated vapors, which further widens the range of substitution. Now that traditional cigarettes are confronted with these e-cigarette substitute products, the demand for traditional cigarettes has become less inelastic.
Do you suppose that the revenues of traditional cigarette firms rise as much as before following a given price increase? Explain.

Question 5

The Demand for First Class Mail Is Not Elastic
Based on what you have learned in this chapter, you might be tempted to jump to the conclusion that the problem faced by the USPS is an elastic demand for its first class mail services. After all, other things being equal, when the change in the amount of an item demanded exceeds the proportionate change in the item's own price, demand is elastic. Furthermore, total revenues decline in response to an increase in an item's price when the demand for the item is elastic.
In fact, study after study of the demand for first class mail concludes that the demand for this USPS service is inelastic. Recent estimates of the price elasticity of demand for first class mail range from as low as less than 0.1 to about 0.8-with most of those estimates closer to 0.1. Thus, the price elasticity of demand for first class mail is not the key explanation for decreases in USPS total revenues from its first class mail services.
The Key USPS Problem: Other Things Have Not Been Equal
Whenever we calculate the price elasticity of demand for an item, we typically assume that all other things than the price of the item and quantity of that item demanded are unchanged. In fact, this assumption has not held true for USPS first class mail since the beginning of this century. Other things were not equal during this period.
The main change that occurred after the earlY ₂000s was the growing utilization of digital devices, together with new telecommunications technologies. At first, people primarily used personal computers to communicate via e-mail. More recently they have utilized tablet devices and smartphones to communicate at no explicit price via e-mail, text messages, and social media. Economists cannot readily estimate the cross price elasticity of demand for USPS first class mail in relation to e-mail and text communications but have estimated the elasticity of demand for USPS first class mail with respect to ownership of digital devices. The elasticity estimates they have obtained indicate that since the earlY ₂000s, increased ownership of digital devices has reduced the demand for USPS first class mail services by more than 30 percent.
The crux of the USPS revenue problem has not been that its prices for first class mail services have increased too much. The difficulty has been that the demand curve for first class mail has shifted leftward considerably over time. Total revenues from first class mail have been decreasing because most people have substituted away from first class mail to digital communications.
Why do you suppose that USPS officials have concluded that significant increases in the price of a first class stamp likely will help to prevent its revenues from falling as rapidly within the next two or three years?

Question 6

Table 19-2 on page 442 indicates that the short-run price elasticity of demand for tires is 0.9. If an increase in the price of petroleum (used in producing tires) causes the market prices of tires to rise from $50 to $60, by what percentage would you expect the quantity of tires demanded to change?

Question 7

The diagram at the next column depicts the demand curve for "miniburgers" in a nationwide fast-food a. What is the price elasticity of demand along the range of the demand curve between a price of $0.20 per miniburger and a price of $0.40 per miniburger? Is demand elastic or inelastic over this range?
b. What is the price elasticity of demand along the range of the demand curve between a price of $0.80 per miniburger and a price of $1.20 per miniburger? Is demand elastic or inelastic over this range?
c. What is the price elasticity of demand along the range of the demand curve between a price of $1.60 per miniburger and a price of $1.80 per miniburger? Is demand elastic or inelastic over this range?

Question 8

In a local market, the monthly price of Internet access service decreases from $20 per account to $10 per account, and the total quantity of monthly accounts across all Internet access providers increases from 100,000 to 200,000. What is the price elasticity of demand? Is demand elastic, unitelastic, or inelastic?

Question 9

At a price of $57.50 to plaY ₁8 holes on local golf courses, 1,200 consumers pay to play a game of golf each day. A rise in the price to $62.50 causes the number of consumers to decline to 800. What is the price elasticity of demand? Is demand elastic, unit-elastic, or inelastic?

Question 10

It is very difficult to find goods with perfectly elastic or perfectly inelastic demand. We can, however, find goods that lie near these extremes. Characterize demands for the following goods as being near perfectly elastic or near perfectly inelastic.
a. Corn grown and harvested by a small farmer in Iowa
b. Heroin for a drug addict
c. Water for a desert hiker
d. One of several optional textbooks in a pass-fail course

Question 11

In the market for hand-made guitars, when the price of guitars is $800, annual revenues are $640,000. When the price falls to $700, annual revenues decline to $630,000. Over this range of guitar prices, is the demand for hand-made guitars elastic, unit-elastic, or inelastic?

Question 12

Suppose that over a range of prices, the price elasticity of demand varies from 15.0 to 2.5. Over another range of prices, the price elasticity of demand varies from 1.5 to 0.75. What can you say about total revenues and the total revenue curve over these two ranges of the demand curve as price falls?

Question 13

Based solely on the information provided below, characterize the demands for the following goods as being more elastic or more inelastic a. A 45-cent box of salt that you buy once a year
B) A type of high-powered ski boat that you can rent from any one of a number of rental agencies
C) A specific brand of bottled water d. Automobile insurance in a state that requires autos to be insured but has only a few insurance companies
E) A 75-cent guitar pick for the lead guitarist of a major rock band

Question 14

The value of cross price elasticity of demand between goods X and Y iS₁.25, while the cross price elasticity of demand between goods X and Z is -2.0. Characterize X and Y and X and Z as substitutes or complements.

Question 15

Suppose that the cross price elasticity of demand between eggs and bacon is -0.5. What would you expect to happen to purchases of bacon if the price of eggs rises bY ₁0 percent?

Question 16

A 5 percent increase in the price of digital apps reduces the amount of tablet devices demanded by 3 percent. What is the cross price elasticity of demand? Are tablet devices and digital apps complements or substitutes?

Question 17

An individual's income rises from $80,000 per year to $84,000 per year, and as a consequence the person's purchases of movie downloads rise from 48 per year to 72 per year. What is this individual's income elasticity of demand? Are movie downloads a normal or inferior good?

Question 18

Assume that the income elasticity of demand for hot dogs is -1.25 and that the income elasticity of demand for lobster iS₁.25. Based on the fact that the measure for hot dogs is negative while that for lobster is positive, are these normal or inferior goods?

Question 19

At a price of $25,000, producers of midsized automobiles are willing to manufacture and sell 75,000 cars per month. At a price of $35,000, they are willing to produce and sell 125,000 a month. Using the same type of calculation method used to compute the price elasticity of demand, what is the price elasticity of supply? Is supply elastic, unitelastic, or inelastic?

Question 20

An increase in the market price of men's haircuts, from $15 per haircut to $25 per haircut, initially causes a local barbershop to have its employees work overtime to increase the number of daily haircuts provided from 35 to 45. When the $25 market price remains unchanged for several weeks and all other things remain equal as well, the barbershop hires additional employees and provides 65 haircuts per day. What is the short-run price elasticity of supply? What is the long-run price elasticity of supply?