Assignment NO 2

Subject Advanced Mangerial Economics

Submitted to Rao M Atif
Submitted By Amara Javaid
FA22-RBA-001
Q. Suppose oil prices rise sharply for years as a result of a war between Ukraine and Russia.
What happens and why to the demand for
a. cars.
b. home insulation.
c. coal.
d. tires
Answers:
If oil prices rise sharply for years due to a war between Ukraine and Russia, it can have several
effects on the demand for various products and industries. Here's how it might impact the
demand for the items you mentioned:
a. Cars:
The demand for cars may decrease or shift towards more fuel-efficient and electric vehicles.
Higher oil prices often lead to increased fuel costs for conventional vehicles, which can make
owning and operating them more expensive. As a result, consumers may be more inclined to buy
fuel-efficient cars or electric vehicles to reduce their fuel consumption and costs. Additionally,
people might consider using public transportation or carpooling to save on fuel expenses, which
could further reduce the demand for new cars.
b. Home Insulation:
The demand for home insulation is likely to increase. When oil prices rise, heating and cooling a
home become more expensive, as oil is used for heating in many households. To mitigate these
increased energy costs, homeowners are incentivized to invest in better insulation to make their
homes more energy-efficient. This can help keep their homes warmer in the winter and cooler in
the summer, reducing the need for constant heating or air conditioning.
c. Coal:
The demand for coal may increase, at least in the short term. When oil prices rise, coal can
become a more attractive option for electricity generation in some regions. Coal is often used as
a substitute for oil in power plants, particularly in areas where coal is abundant and oil is used in
power generation. However, in the long run, the shift towards cleaner and more environmentally
friendly energy sources like natural gas, renewables, and nuclear power may offset any
significant increase in coal demand.
d. Tires:
The demand for tires may decrease slightly. Higher oil prices can lead to increased
manufacturing and transportation costs for tire producers, which may result in slightly higher
prices for consumers. As a result, some consumers might postpone tire replacements or opt for
more durable, longer-lasting tires to reduce the frequency of replacements. However, the impact
on tire demand may be relatively modest compared to other industries, as the need for safe and
functional tires remains essential for vehicle safety.
It's important to note that the effects on these industries will depend on the duration and severity
of the oil price increase, as well as other economic and geopolitical factors. Long-term trends,
such as increasing environmental awareness and policies aimed at reducing reliance on fossil
fuels, can also influence these dynamics.

Q. If the price of a good or service increases and the total revenue received by the seller
declines, is the demand for this good over this segment of the demand curve elastic
or inelastic? Explain.
Answer:
If the price of a good or service increases and total revenue decreases, it indicates elastic
demand. Consumers respond significantly to price changes, leading to decreased total revenue
for the seller when prices rise.
Q. Suppose the price elasticity of demand for farm products is inelastic. If the federal
government wants to follow a policy of increasing income for farmers, what type of
programs will the government enact?
Answer:
When demand is inelastic, the percentage change in price causes a smaller percentage change in
quantity. This means the government can increase the price, but the quantity sold will decrease
by very little. Because the increase in price will overpower the decrease in quantity demanded,
Farmers revenue will increase. Programs that increase the price of farm products may include
advertising farm products, purchasing farm products directly, or giving tax incentives for people
to buy local farm products.

Q. Suppose the price elasticity of demand for used cars is estimated to be 3. What does this
mean? What will be the effect on the quantity demanded for used cars if the price rises
by 10 percent?
Answer:
Elasticity of more than one signify elastic demand. When demand is elastic, percentage change
in quantity demanded is greater than the percentage change in price. In this scenario since the
price elasticity of demand is 3, every 1% change in the price will result in a 3% change in the
quantity demanded (in the opposite direction). This means that when the price rises by 10%,
quantity demanded will decrease by 30%. Because the percentage decrease in quantity is
significantly greater than the percentage increase in price, total revenue the product of price and
quantity will decrease. Know that should the price elasticity of demand be less than one demand
would be inelastic. The percentage decrease in quantity would be smaller than the percentage
increase in price, and total revenue would increase.
Q. Consider the following demand schedule:
Price Quantity
25 20

20 40

15 60

10 80

5 100

What is the price elasticity of demand between

a. P $25 and P $20?
b. P $20 and P $15?
c. P $15 and P $10?
d. P $10 and P $5?
Answer:
To calculate the price elasticity of demand (PED) for each price range, you can use the following formula:
PED = (% Change in Quantity Demanded) / (% Change in Price)
Let's calculate the PED for each of the price ranges you mentioned:

a. Between $25 and $20:

Initial Price (P1) = $25

New Price (P2) = $20
Initial Quantity (Q1) = 20
New Quantity (Q2) = 40

% Change in Quantity Demanded = [(Q2 - Q1) / Q1] * 100% = [(40 - 20) / 20] * 100% = 100%
% Change in Price = [(P2 - P1) / P1] * 100% = [($20 - $25) / $25] * 100% = -20%

PED (a) = (100% / -20%) = -5

b. Between $20 and $15:

Initial Price (P1) = $20

New Price (P2) = $15
Initial Quantity (Q1) = 40
New Quantity (Q2) = 60

% Change in Quantity Demanded = [(Q2 - Q1) / Q1] * 100% = [(60 - 40) / 40] * 100% = 50%
% Change in Price = [(P2 - P1) / P1] * 100% = [($15 - $20) / $20] * 100% = -25%

PED (b) = (50% / -25%) = -2

c. Between $15 and $10:

Initial Price (P1) = $15

New Price (P2) = $10
Initial Quantity (Q1) = 60
New Quantity (Q2) = 80

% Change in Quantity Demanded = [(Q2 - Q1) / Q1] * 100% = [(80 - 60) / 60] * 100% = 33.33%
% Change in Price = [(P2 - P1) / P1] * 100% = [($10 - $15) / $15] * 100% = -33.33%

PED (c) = (33.33% / -33.33%) = -1

d. Between $10 and $5:

Initial Price (P1) = $10

New Price (P2) = $5
Initial Quantity (Q1) = 80
New Quantity (Q2) = 100

% Change in Quantity Demanded = [(Q2 - Q1) / Q1] * 100% = [(100 - 80) / 80] * 100% = 25%
% Change in Price = [(P2 - P1) / P1] * 100% = [($5 - $10) / $10] * 100% = -50%

PED (d) = (25% / -50%) = -0.5

So, the price elasticity of demand for each price range is as follows:
a. PED = -5
b. PED = -2
c. PED = -1
d. PED = -0.5

These values indicate the responsiveness of quantity demanded to changes in price for each respective
price range.
Q.6. Suppose a university raises its tuition from $3,000 to $3,500. As a result, student
enrollment falls from 5,000 to 4,500. Calculate the price elasticity of demand. Is
demand elastic, unitary elastic, or inelastic?

The price elasticity of demand measures how much the quantity demanded of a good respond to
a change in the price of that good. It is calculated using the midpoint formula:
Elasticity = (Q2 - Q1) / ((Q2 + Q1) / 2) / (P2 - P1) / ((P2 + P1) / 2)
Where:
 Q1 and Q2 are the initial and final quantities, respectively.
 P1 and P2 are the initial and final prices,
respectively. In your case:
 Q1 = 5000 students
 Q2 = 4500 students
 P1 = $3000
 P2 = $5000
Substituting these values into the formula, we get:
Elasticity = (4500 - 5000) / ((4500 + 5000) / 2) / (5000 - 3000) / ((5000 + 3000) / 2)
After performing the calculations, we get:
Elasticity = -0.222
The elasticity of demand is negative, which is typical as price and quantity demanded usually
move in opposite directions. We ignore the negative sign and focus on the absolute value when
interpreting the elasticity.
The absolute value of the elasticity is less than 1, which means the demand is inelastic. This
means that the percentage change in quantity demanded is less than the percentage change
in price. In other words, students' enrollment is not very responsive to changes in tuition.
Q. Will each of the following changes in price cause total revenue to increase, decrease,
or remain unchanged?
a. Price falls, and demand is elastic.
b. Price rises, and demand is elastic.
c. Price falls, and demand is unitary elastic.
d. Price rises, and demand is unitary elastic.
e. Price falls, and demand is inelastic.
f. Price rises, and demand is inelastic.
a. Price falls, and demand is elastic:

 Total revenue increases.

 When the price falls and demand is elastic, the percentage increase in quantity demanded
is greater than the percentage decrease in price. As a result, the increase in sales volume
more than compensates for the lower price, leading to higher total revenue.

b. Price rises, and demand is elastic:

 Total revenue decreases.

 When the price rises and demand is elastic, the percentage decrease in quantity demanded
is greater than the percentage increase in price. As a result, the decrease in sales volume
more than offsets the higher price, leading to lower total revenue.

c. Price falls, and demand is unitary elastic:

 Total revenue remains unchanged.

 When the price falls and demand is unitary elastic, the percentage increase in quantity
demanded is equal to the percentage decrease in price. As a result, the change in total
revenue is neutral, and it remains the same.

d. Price rises, and demand is unitary elastic:

 Total revenue remains unchanged.

 When the price rises and demand is unitary elastic, the percentage decrease in quantity
demanded is equal to the percentage increase in price. Consequently, total revenue
does not change.

e. Price falls, and demand is inelastic:

 Total revenue decreases.

  When the price falls and demand is inelastic, the percentage increase in quantity
demanded is smaller than the percentage decrease in price. As a result, the decrease
in price more than offsets the increase in sales volume, leading to lower total revenue.

f. Price rises, and demand is inelastic:

 Total revenue increases.

 When the price rises and demand is inelastic, the percentage decrease in quantity
demanded is smaller than the percentage increase in price. The higher price leads to a
more significant increase in total revenue compared to the decrease in sales volume.

Q. Suppose a movie theater raises the price of popcorn 10 percent, but customers do not buy
any less popcorn. What does this tell you about the price elasticity of demand? What will
happen to total revenue as a result of the price increase?
Answer:
Arc elasticity may be expressed as: [(Q1 - Q)/(Q1 + Q)] x [(P1 + P)/(P1 - P)]
Therefore,
[(300 - 200)/(300 + 200)] x [(200 + 120)/(200 - 120)]
= (100/500) x (320/80)
So, Arc elasticity = 4/5 = 0.8
(differences were large hence arc elasticity is used.)
Q. Charles loves Mello Yello and will spend $10 per week on the product no matter what
the price. What is his price elasticity of demand for Mello Yello?
Answer:
If Charles is willing to spend a fixed amount of $10 per week on Mello Yello, regardless of the
price, it indicates that his demand for Mello Yello is perfectly inelastic. This means that the
quantity he purchases remains the same, regardless of the price.

Price Elasticity of Demand (PED) measures the responsiveness of quantity demanded to changes
in price. In the case of perfect inelasticity, PED is zero because there is no change in quantity
demanded when the price changes. Charles's PED for Mello Yello is 0, indicating a perfectly
inelastic demand.

Q. Which of the following pairs of goods has the higher price elasticity of demand?
a. Oranges or Sunkist oranges
b. Cars or salt
c. Foreign travel in the short run or foreign travel in the long
run Answer:

a. Oranges or Sunkist oranges:

Sunkist oranges are a specific brand of oranges. If the prices of Sunkist oranges rise
significantly, consumers can easily switch to generic or other brands of oranges, making the
demand for Sunkist oranges more elastic.

b. Cars or salt:

Cars are typically considered a more expensive and significant purchase, so their demand tends
to be relatively elastic. On the other hand, salt is a basic and inexpensive commodity with few
substitutes, making its demand more inelastic.

c. Foreign travel in the short run or foreign travel in the long run:

In the short run, travel plans are often more inflexible due to factors like booking restrictions and
limited alternatives, so the demand for foreign travel in the short run tends to be less elastic. In
the long run, consumers have more flexibility and can adjust their travel plans more easily,
making the demand for foreign travel in the long run more elastic.

In each of these pairs, the goods with more available substitutes or those that are considered less
essential tend to have higher price elasticity of demand. Therefore:

a. Oranges or Sunkist oranges - Sunkist oranges likely have a higher price elasticity
of demand.

b. Cars or salt - Salt likely has a lower price elasticity of demand.

c. Foreign travel in the short run or foreign travel in the long run - Foreign travel in the
long run likely has a higher price elasticity of demand.

Q. Suppose the income elasticity of demand for furniture is 3.0 and the income elasticity of
demand for physician services is 0.3. Compare the impact on furniture and physician
services of a recession that reduces consumers’ incomes by 10 percent.
Answer:

The income elasticity of demand measures how sensitive the quantity demanded of a good
or service is to changes in consumer income. Specifically:
If the income elasticity of demand is greater than 1 (elastic), it indicates that the good is a luxury,
and as consumer income increases, the demand for the good increases by a greater percentage.

If the income elasticity of demand is between 0 and 1 (inelastic), it indicates that the good is a
necessity, and as consumer income increases, the demand for the good increases, but by a
smaller percentage.Now, let's consider the impact of a recession that reduces consumers'
incomes by 10 percent on the demand for furniture and physician services based on their
respective income elasticities

Furniture (Income Elasticity = 3.0):

With an income elasticity of 3.0, furniture is considered a luxury good.When consumers'

incomes decrease by 10 percent due to the recession, the demand for furniture is expected to
decrease, but the decrease will be relatively larger (more than proportionate) because the income
elasticity is greater than 1.So, the demand for furniture is likely to decrease by more than 10
percent.

Physician Services (Income Elasticity = 0.3):

With an income elasticity of 0.3, physician services are considered a necessity.When consumers'
incomes decrease by 10 percent due to the recession, the demand for physician services is
expected to decrease, but the decrease will be relatively smaller (less than proportionate) because
the income elasticity is less than 1.So, the demand for physician services is likely to decrease by
less than 10 percent.

In summary, during a recession that reduces consumer incomes by 10 percent, the demand for
furniture, being a luxury with an income elasticity of 3.0, is likely to decrease more significantly,
while the demand for physician services, being a necessity with an income elasticity of 0.3, is
expected to decrease to a lesser extent.