Econ 172

Homework 2

Due Monday, Jan 31

 

From chapter 2:

Problems

2.9

 

Month

AA Price

UA Price

Income

AA Load Factor

UA Load Factor

1

110

112

2000

65

60

2

109

110

1900

62

63

3

110

112

2100

70

66

4

109

111

1900

70

61

5

108

110

1900

68

59

For all of these (a-c) I took the average of each month’s data and the min to max range and the change in quantity.

a.  The price elasticity of demand is 6.5.   I took the quantity as the change over the 62 to 70 load factor range (8) and the price as the change over the 108 to 110 price range.   The average price is 109.2 and the average load factor is 65.

The income of elasticity of demand for American seats is 1.2.

The cross price elasticity is 6.6.

b.  Based on this data, United is a substitute since the cross price elasticity is positive.  When the price of United tickets goes up, the quantity demanded of AA tickets rises; the cross price elasticity is positive.

c.  American’s economy seats are a normal good.  When incomes go up, people buy more American tickets.  The income elasticity is positive.

d.  If consumers had more time to respond, demand elasticity would be larger.   Price elasticity of demand is always greater over a longer time as consumers have more time to adjust to price changes.

e.  The demand elasticity for seats in the Chicago-Columbus market in general is more inelastic than the demand elasticity for United or American.  There are more substitutes for American seats than there are for seats on planes from Columbus to Chicago.  A good substitute for American seats are United seats.  A substitute for airline seats is car travel; not such a good substitute.

 

 

2.12

 

a.  Note that when the US government enters the market, the equilibrium price is bid up to $10 from the original price of $5.

US domestic consumers now face a price of $10 per bushel.  They now buy less than Q* , the original quantity purchased (which I have arbitrarily set at 10).  How much less?  At a price of $10, on the original demand curve, they would have only bought 5 < Q* bushels. (I have assumed 5; I know it must be less than 10.) So consumers pay $10 x 5 or a rectangle that you can draw on the graph from the origin to 5 on the x axis and up to 10 on the y axis.  The area of this rectangle is $50.

 

The government buys the remaining grain (Q* - 5) = 5 bushels and pays $10 per bushel so the government pays $50 as well.  Whatever numbers you use, the total amount spent is the same for both groups.

 

b.  Now the government pays a subsidy of $5 per bushel to farmers.  Consumers see no change in the price, so they still pay $5 and buy the same amount.  But now the farmers get an additional $5 per bushel from the government.  The government gets no corn, but it pays the farmers $5 x Q*, which is the same as they spent before.    So there is no difference in cost to the government.

 

 

2.17

 

 

 

Since it is illegal to sell organs, the price ceiling is effectively $0.  So the excess demand (shortage) is the amount by which quantity demanded exceeds quantity supplied at a price of $0.  On the graph is is 15 kidneys    The supply curve interesected the demand curve at a price of $5.7 million.

 

2.19

 

If the cross price elasticity is low, that means that Microsoft could raise its price without much fear of losing sales to Linux or other open source software.  (The real issue was Microsoft’s Windows cross price elasticity with Linux, not MS-DOS.)  So was Linux a good substitute for Microsoft Windows in users’ views or was it not?

 

 

 

 

And the following:

 

 

1. Suppose a National Institutes of Health study finds that using battery powered toys is bad for children's intellectual and emotional development.   Show the impacts on the following markets.  Be sure to label all relevant points and graphs and clearly show what happens to equilibrium price and quantity.

 

a. The market for battery powered toys.

 

Without doing the graphs:  The demand for battery powered toys would decline (shift left) due to health safety concerns.  So the price and equilibrium quantity would both fall.

 

b. The market for batteries used in toys.

 

Same as (a) .  Decrease in demand.  Batteries are a complementary good to battery powered toys, so when the demand for toys falls, so too does the demand for batteries.

 

c. The market for yo-yos (the ones without batteries).

 

Yo-yos and battery powered toys are substitutes, so the demand for Yo-yos would increase.  The price would rise as would the quantity bought and sold.

 

2.    Business Week magazine (February 16, 2004) reported that when JetBlue Airlines entered the New York City to Buffalo market, the average fare between the two cities fell by 40% and the number of passengers traveling by air between the two cities rose by 94%.

 

a.   What was the price elasticity of demand for air travel between these two cities?

 

An approximation would be that it is 94/40 =2.35.

 

 

b.  Is air travel demand between New York and Buffalo price elastic or inelastic?  Briefly explain why.

 

2.35 represents elastic demand.   There are substitutes such as driving, so when the price of air travel fell, many people flew who previously would have driven or not gone at all.

 

 

c.  Business Week also reported that when JetBlue entered the New York to Los Angeles market, average fares fell by 26% and the number of passengers traveling rose by 2%.   What was the price elasticity of demand for air travel between these two cities?

 

Price elasticity is 2/26 = .08 

 

d. Is air travel demand between New York and Los Angeles elastic or inelastic.  Briefly explain why.

 

 This is very inelastic demand.   Although prices went down, there are no good substitutes for flying; it’s too far to drive and evidently there weren’t many people who were deterred from flying between the two cities due to price.