Question

Please answer the following with both i) any appropriate calculations; and ii) what those calculations tell us.

1. Suppose that a 20% increase in the price of gasoline causes a 5% decrease in the consumption (purchases) of gasoline and a 30% drop in the sales of SUVs. What kinds of elasticities are involved here? What are the coefficients of elasticity? What do they tell us?

2. The Metropolitan Transit System recently announced a 50% increase in the price of a daily bus pass. The administrators said that they needed an increase in revenue to cover their rising costs. Explain the economic rationale for this decision. (No calculation here, but what are those transportation people thinking?)

3. A gasoline station very near a professional football stadium parks cars on its lot to make money on game days. Last year it charged $4.00 per car and parked 1000 cars. This year it raised the parking price to $5.00 and parked 850 cars. Did the station owner make a good economic decision in raising the parking prices from one year to the next? Explain.

d) Bonus. As the demand for software developers increases, wages rise. Assuming it takes at least three years to become a skilled software developer, and that the demand for software developers is expected to grow for the next eight years, what can we say about the elasticity of supply of software developers (1) during the current year; and (2) six years from now.  (Think of wages as the price of labor.)

Answer 1

(1)

(a) The relevant elasticities are:

(i) Own price elasticity of demand for gasoline

(ii) Cross-price elasticity of demand between gasoline and SUV

(b)

(i) Own price elasticity of demand for gasoline = % change in quantity demanded of gasoline / % change in price of gasoline

= (-5%) / 20%

= -0.25

(ii) Cross price elasticity = % change in demand for SUV / % change in price of gasoline

= (-30%) / 20%

= -1.5

(c)

(i) Since absolute value of own price elasticity of demand for gasoline is less than 1, demand for gasoline is inelastic, indicating that a rise (fall) in price of gasoline will increase (decrease) total revenue.

(ii) Since cross-price elasticity between gasoline and SUV is negative, it means that gasoline and SUV are complements.

NOTE: As per Answering Policy, 1st question is answered.