Tutorial 2solutions 15-16

2nd Tutorial The Theory of Demand Solutions True of False 1. The law of demand states that as the price of a product falls, the willingness to demand increases. True. Willingness to demand has an inverse relationship with price. See Figure 2.1 of Begg and Ward. True/False 2. A rise in income will lead to a rise in demand for a product. False. A rise in income will raise demand for normal goods, but will reduce demand for inferior goods. See section 2.3 of Begg and Ward. True/False 3. Mortgages and homes are complements. True. Generally, in order to purchase a house, a mortgage is also needed. The two goods are purchased together. See section 2.3 of Begg and Ward. True/False 4. An income elasticity of 1.5 suggests that demand is not responsive to a change in income. False. If the elasticity of demand is greater than 1, then demand is said to be elastic, or responsive to a change in price. See section 2.4 and Table 2.1 of Begg and Ward. True/False 5. The price elasticity remains constant throughout a product life cycle. False. Successful products tend to go through four stages: Introduction, growth, maturity and decline. Each stage is characterised by different levels of competition, leading to differing substitutability and differing elasticities of demand for the products. True/False 6. CD’s in music shops cost £14.00, in supermarkets they cost £9.00. You are only willing to buy CD’s at £9.00, your consumer surplus is £5.00. False. The consumer surplus is zero. Consumer surplus is the difference between what you are charged and what you would be willing to pay. Therefore, in this case consumer surplus is £9 - £9 = 0. See section 2.7 of Begg and Ward. True/False Question 1 The following expression shows the demand equation for a product: D = 480 – 6p where p is price in £. Create a demand schedule in the table below and show total revenue (TR): Price 0 10 20 30 40 50 60 70 80 Quantity 480 420 360 300 240 180 120 60 0 TR 0 4200 7200 9000 9600 9000 7200 4200 0 Plot the demand curve from your schedule on the graph below: Show which part of the demand curve might be elastic and which might be inelastic. Students should realise that the elasticity changes along the demand curve. They should know the connection between elasticity and total revenue and use part a. to show this on the demand curve. If the price increases from £20 to £30 per unit what is the price elasticity of demand? Ped = -0.333, i.e. the demand for the product is inelastic. Now calculate the price elasticity of demand for a change in price from £60 to £70. Ped = -3, i.e. the demand for the product is elastic. Question 2 You are asked to advise on the relationship between two products. The only information you know is that if you increase the price of your product from £1.50 to £1.80, the demand for your competitors’ product increases from 1,000 units to 1,300. What economic tool could you use to help you advise? What is the relationship between yours and your competitor’s product? Cross price elasticity of demand for Good X = 1.5. X price elasticity is positive so the products must be substitutes for each other. Stress that this is important for the business environment as rival companies may alter the price of their products and this may have a significant impact on your trading depending upon the substitutability of the products. Question 3 I have managed to gain a pay rise of £10,000 per annum. My salary per annum is now £80,000. This means that I will now take two cruises instead of one. Calculate the income elasticity of demand. Yed = 7 The value of 7 shows that taking a cruise is highly income elastic. 1