- Discuss the relative price elasticity of the following products:
- A specific brand of mayonnaise
- Chevrolet automobiles
- Jaguar automobiles
- Washing machines
- Air travel (vacation)
- Diamond rings
- a) The elasticity for mayonnaise is relatively inelastic because it is a staple dressing, and it only accounts for a small portion of routine family or personal expenditures. Demand is unlikely to vary considerably with changes in price.
- b) The price elasticity for a specific brand of mayonnaise is relatively elastic, since there are many competing brands of mayonnaise on the market. The availability of close substitutes renders any one brand relatively price elastic.
- c) Chevrolet automobiles are price elastic, for two reasons. Foremost, they have many competing substitutes (other car brands). Secondly, their prices account for a large portion of routine personal or family expenditures. Consumers are therefore sensitive to changes in price.
- d) As a luxury car brand, jaguar cars are considered to be elastic. However, jaguars are typically purchased by individuals with high incomes. In addition, luxury car models such as Jaguar are valued for more than their innate performance: they are status symbols. Luxury cars are examples of Giffen goods: goods whose demand tends to rise with increases in prices. Jaguar cars are therefore relatively inelastic.
- e) Washing machines are relatively elastic. First, they represent a large portion of family or personal budgets, and consumers are therefore sensitive to price changes. They are also purchased infrequently by individuals and families; they are not repetitive purchases. For these reasons, their demand is price elastic.
- f) The demand for leisurely air travel is elastic. Leisurely air travel is a luxury good. Air tickets also represent a large portion of family and individual budgets. Lastly, leisurely air travel has many substitutes including car and train travel. Similarly, overseas vacations have many close substitutes.
- g) The demand for beer is price inelastic. Beer has few close substitutes; alcoholic drinks such as wines and whiskey are not close enough to beer to be considered substitutes. Beer is also an addictive good. In addition, beer purchases represent a small portion of individual budgets.
- h) Diamond rings are price elastic. They represent a large portion of individual budgets, and there are many close substitutes for diamond rings (such as gold and platinum).
- Would you expect the cross-elasticity coefficients between each of the following pairs of products to be positive or negative? Why?
- Personal computers and software
- Electricity and natural gas
- Apples and oranges
- Bread and DVRs
- a) Negative. The goods are complements; their cross-elasticity coefficients is negative.
- b) Positive; electricity and natural gas are substitute goods.
- c) Positive; apples and oranges are substitute goods.
- d) The two goods are unrelated products; their cross-elasticity of demand is therefore zero.
- Why do you think that whenever governments (federal and state) want to increase revenues, they usually propose an increase in taxes on cigarettes and alcohol?
Federal and state governments typically propose tax increases on alcohol and cigarettes because of their understanding of the price elasticity of these goods, in addition to the fact that these goods lend themselves well to increased taxation. Alcohol and cigarettes are price inelastic for several reasons. First, they are addictive, which renders consumers insensitive to prices. Secondly, they represent small portions of individual budgets. Alcohol and cigarettes have no close substitutes; another reason why their demand is insensitive to price increases. Being price inelastic, price increases resulting from increased taxation do not cause considerable declines in consumption. Apart from being price inelastic, alcohol and cigarettes also carry a social stigma because of the health and behavioral risks they pose. There is little political resistance to tax increases on alcohol and cigarettes; in fact, society generally lauds such tax increases. Lastly, alcohol and cigarettes are consumed widely, by millions of people in many countries. Tax increases on them therefore generate sufficient quantities of revenue.
- If a demand curve facing a firm is horizontal or nearly so, what does it say about this firm’s competition?
A firm with a horizontal or nearly horizontal demand curve faces stiff competition. If it raised its price by a small amount, it is liable to lose all or nearly all of its patrons. This means that the firm has numerous competitors willing to supply at the prevailing price.
- Would you expect cross-price elasticity between the following pairs of products to be positive, negative, or zero?
- Television sets and DVRs
- Rye bread and whole wheat bread
- Construction of residential housing and furniture
- Breakfast cereal and men’s shirts.
Explain the relationship between each pair of products.
- Television sets and DVR’s- the cross-price elasticity is negative; the goods are complements. An increase in the price of one good causes a decrease in the demand of the other
- Rye bread and whole wheat bread- the cross-price elasticity is positive; the goods are substitutes. An increase in the price of one good causes a decrease in the demand of the other.
- Construction of residential housing and furniture- the cross-price elasticity is negative; the goods are complements. An increase in the price of one good causes a decrease in the demand of the other. For example, an increase in the price of residential housing causes a decrease in demand for residential housing. This causes a decrease in the demand for furniture, since there are fewer residential houses to fill with furniture.
- Breakfast cereal and men’s shirts- These two goods bear no relationship; they are neither substitutes nor complements. Their cross-price elasticity is zero.
- In order to attract more customers on Mondays (a slow day), Alex’s Pizza Shop in Austin decided to reduce the price of their pizza rolls from $3.50 to $2.50. As a result, Monday sales increased from 70 to 130. Also, Alex’s sales of soft drinks rose from 40 to 90. a. Calculate the arc price elasticity of demand for the pizza rolls. b. Calculate the arc cross-price elasticity of demand between soft drink sales and pizza rolls prices.
- 130 – 70 2.50 – 3.50
Ep = —————— / ————
130 + 70 2.50 + 3.50
EP = 1.8
- 90 – 40 2.50 – 3.50
Ex = —————— / ————
90 + 40 2.50 + 3.50
Ex = 2.3