Elasticity of Demand

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Assignment

In this Assignment, you will focus on marginal utility, Price Elasticity of Demand, and understanding the difference between Price Elasticity of Demand and Income Elasticity of Demand.

We all subconsciously assign “scores” to what we are considering to purchase, based on our expected level of “satisfaction” (Marginal Utility) with that purchase. When making simultaneous pairs of purchases, again we subconsciously compare the amount of “satisfaction” (Marginal Utility) that we will receive from the pair of purchases. To decide on the “ideal” combination of these two purchases, we expect that the last dollar we spend on each of the items will give us the “same” satisfaction per dollar (Marginal Utility per dollar). Further, we know that the MORE of an item that we get, the next one we get will give us LESS “satisfaction” Marginal Utility) than the last one gave us (the Law of Diminishing Marginal Utility). Using what you have learned about Marginal Utility and Marginal Utility per dollar, answer the following questions.

Questions

1. Jane has been working all day, missing both her breakfast and lunch. Finally able to leave work, after being required to work a couple of hour’s overtime, she is starving. Jane has $20 in her pocket, so she stops at a local fast food restaurant and orders a grilled chicken sandwich (somewhat healthy) and fries (not so healthy). As she sits down to eat them, a Kaplan University student approaches her and tells her that she is doing a research project for her microeconomics course, and would like to ask Jane a few quick questions. Jane agrees and the student asks what “score” (Marginal Utility) from 1 to 100 would she give as her satisfaction level with the 1st sandwich and the 1st fries? After eating that order, Jane is still hungry and orders a second chicken sandwich and another fries. Again, the student asks Jane to give her new scores. Since Jane has not eaten all day, she is hungry enough to order a third round of food and again gives “scores” to the inquisitive student.

Below is the Kaplan student’s completed experiment tally sheet of Jane’s marginal utility “scores” and the calculation of her marginal utility per dollar, given that each sandwich costs $4.00 and each order of fries costs $2.00, along with her budget of $20. The student filled in the shaded cells based on Jane’s responses, then computed the values in the remaining cells. Using this information, answer the following questions:

a. Is Jane maximizing her utility? Explain your reasoning and show any calculations.

Jane is not maximizing her utility being that she is not using the entire budget that she has. After her consumption, she is left with $2 meaning that she does her utility is not being maximized. After consuming the first sandwich and the first fries, she fails to have an equal marginal utility per dollar across all the goods that she is consuming. It is important to note that the first sandwich and fries will meet the criteria but the other items consumed will not add up.

Both 1st sandwich and fries has MU/$ of 2

2nd sandwich has MU/$ of 18 while the 2nd fries has MU/$ of 10

3rd sandwich has a MU/$ of 15 while the 3rd fries has a MU/$ of 3

As seen above, there is no match in the 2nd and 3rd items that she consumes.

b. If Jane is not maximizing her utility, remembering the Law of Diminishing Marginal Utility, would she be better off to buy one less chicken sandwich and one more fry? Explain your reasoning and show any calculations.

In the present state, the total utility for Jane is at 308 but if Jane was to buy one less sandwich then her utility would be 172 from the two sandwiches and 76 from the 3 fries. The total utility has then dropped down for fries from 50 to 20 to 6. According to the law of diminishing marginal utility, the utility for fries will continue to drop. Taking an assumption that the utility for the next fries is 2 then the total for 4 fries would then grow to 78. This if added to 172 from the sandwiches, the total will be 250 which is less than 308 that she currently has.

c. If Jane is not maximizing her utility with the original purchase combination, remembering the Law of Diminishing Marginal Utility, would she be better off buying just one more fry? Explain your reasoning and show any calculations.

Jane will not be better off buying one more fry based on the law of diminishing marginal utility due to the fact that the marginal utility she gains from the fries are much lower when compared to the sandwich. So she would be better off purchasing another sandwich and not fries.

d. If Jane is not maximizing her utility with the original purchase, remembering the Law of Diminishing Marginal Utility, would she be better off buying one less fries and one more chicken sandwich? Explain your reasoning and show any calculations.

Jane obtained much more satisfaction from the chicken sandwich as compared with the fries based on the current scores from the tally sheet. Therefore, she will be in able to maximize her marginal utility by purchasing another chicken sandwich as opposed to buying another fry.

2. Remembering the Learning Practice in Unit 3, in the year 107 WBCE (Way Before the Common Era) the Gondwanaland Chairman of Production reported that the gosum berry growers were able to meet an average demand of 700 barrels of gosum berries per month at an average a price of $70 per barrel.

In the year 108 WBCE the growers were plagued with a gosum berry bug infestation that reduced average output, causing production to fall to only 600 barrels per month, causing the price to rise to $84 per barrel. The following table shows the Chairman’s report:

Year (WBCE)

Monthly barrels of gosum berries demanded

Price per barrel

107

700

$70

108

600

$84

a. Using the midpoint method, calculate the price elasticity of demand for Gondwanaland gosum berries. Explain what this price elasticity of demand means?

Percent change in quantity demanded= -100/ (700+600)/2= -100/650=-15.38%.

Percent change in price is 14/ (70+84)/2=14/77= .18 * 100 = 18%.

Price elasticity of demand using the midpoint method is 15.38/18=.85;

Price elasticity of demand is less than 1 than its inelastic, which means the price increase due to few customers to stop buying and increase of revenue

b. What is the monthly average total revenue for year 107, and the monthly average total revenue for year 108? How do these numbers compare to each other?

Year (WBCE)

Monthly barrels of gosum berries demanded

Price per barrel

Monthly average total revenue

107

700

$70

49,000

108

600

$84

50,400

Change in

average total monthly revenue

c. Using your answer to part a. above, how could you have predicted this change in total monthly revenue?

The answer in part a can be applied in the prediction of a change in the total monthly revenue due to the small change in price. Therefore as price rises, the quantity demanded seem to have gone down and that is a representation of the law of demand and that will lead to less impact on the total revenue thus increasing the monthly revenue with a slight variation from the current revenues.

3. The Gondwanaland Chairman of Production reported that the new Altair chariots (most modern, horse drawn family chariot) had a PRICE elasticity of 3 and an INCOME elasticity of 2. The supply of these Altair chariots is elastic. Evaluate the following statements and explain why you think they are true, or false.

a. A 20% increase in the price of the Altair chariot will cause the quantity demanded to fall by an astounding 60%.

According to the information given the price elasticity is 3.

Therefore, 3 = 60% change in demand / 20% change in price. 60/20 = 3.

Since the curve tells us an increase in price comes with a decrease in demand I would consider this calculation to be true.

b. An increase in Gondwanaland consumers’ incomes will cause prices to rise, but the total quantity demanded will also increase.

The statement is true. As the Gondwanaland consumers’ income increases, it will cause the price to increase as well as the demand for the commodities.

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References:

Samuelson, P. A., & Nordhaus, W. D. (2010). Economics. New Delhi: Tata McGraw Hill.

Stretton, H. (1999). Economics: A new introduction. London: Pluto Press.

Arnold, R. A. (2010). Economics. Australia: South-Western Cengage Learning.

Unit 4 Assignment: Elasticity of Demand Grading Rubric

Content

Percent Possible

Points Possible

Full Assignment

100%

40

Overall Writing:

20%

8

Correct coversheet information at the top of 1st page

5%

2.00

APA format for answers

3%

1.20

Correct citations

3%

1.20

Standard English, no errors

4%

1.60

At least one, or more, references

5%

2.00

Answers: provides complete information demonstrating analysis and critical thinking:

80%

32

Individual Questions:

1. a. - Are the utility maximizing quantities 3 sandwiches and 3 fries? Why?

5%

2.00

1. b. - Are the utility maximizing quantities 2 sandwiches and 4 fries? Why?

5%

2.00

1. c. - Are the utility maximizing quantities 3 sandwiches and 4 fries? Why?

5%

2.00

1. d. - Are the utility maximizing quantities 4 sandwiches and 2 fries? Why?

5%

2.00

2. a. - What is price elasticity of demand for gosum berries?

15%

6.00

2. b. - What is year 107 revenue and the year 108 revenue?

10%

4.00

2. c. - Could change in revenue been predicted from elasticity? How?

15%

6.00

3. a. - Will quantity of Altair chariots demanded fall by 60%? (true/false) Why?

10%

4.00

3. b. - Will quantity of Altair chariots demanded increase? (true or false) Why?

10%

4.00

Sub-total for Individual Questions:

80%

32