Answer to Question #165910 in Microeconomics for Dennis Yawson

Question

a) You have the following information for your product:

 The price elasticity of demand is -0.9.

 The income elasticity of demand is 0.5.

 The cross-price elasticity of demand between your good and a related good

is 2.0.

What can you determine about consumer demand for your product from this

information?

b) The price elasticity of demand for urban transit fares has been estimated to lie

between -0.1 and -0.6. Based on these results, what is the economic argument for raising

transit fares? What political arguments might local governments and transit authorities

encounter in opposition to these economic arguments?

Answer 1

a) The price elasticity of demand can determine the movement in quantity demand versus a shift in the price. It can denote how flexible consumers are about their purchase based on how consumers respond to a price change. The price elasticity of demand of this good is –0.9, making the shift in price, the denominator, greater than the movement in demand, the numerator since the value is not a whole number. Consumers are very flexible about the price of this good. Consumer demand for this goodwill changes less than the price because the price elasticity of demand is inelastic.

Income elasticity of demand represents how much a shift in income affects moves quantity demanded to determine if the good is a luxury, necessity, normal, or inferior. The income elasticity of demand for this good is 0.5. The movement in demand, the numerator, is less than the shift in income, the denominator because the value is not a whole number. Consumer demand for this goodwill increase when income increases because this good is a necessity. Also, the consumer demand for this goodwill decrease if income decreases because this good is a necessity.

The cross-price elasticity of demand represents how a movement in the quantity demanded of one good is affected by the shift in the price of another good. This determines if the goods are substitutes or complements. The cross-price elasticity of demand for this good is 2.0, meaning that these two goods are substitutes. The value is positive because consumers want to buy one good or the other and not both. Consumer demand for this goodwill rise if the price rises for the other good and falls if the price lowers for the other good.

b) The price elasticity of demand represents how a change in price affects a change in demand. Price elasticity of demand is given as percent change in demand divided by percent change in price. The price elasticity of demand of this good is lies between –0.1 and –0.6, making the percent change in price greater than the percent change in demand. Raising the price of the transit fare will raise revenue because the demand will not change much from a price increase.

Transit authorities may encounter opposition if anyone feels that the price is being raised unfairly because there aren’t any close substitutes to public transportation. If a person is reliant on the bus to get around then there isn’t much they can do if the price of fare rises. A rise in transit fares could be seen as taking unfair advantage of transit consumers.