3-5. Calculation and application of elasticity. (15 points) a) Let\'s consider t

Question

3-5. Calculation and application of elasticity. (15 points) a) Let's consider two smokers A and B who, following a 20% decrease in the price of cigarettes, increase their smoking by 6% and 30%, respectively. i. What is the price elasticity of demand for each consumer? Show all the steps of your calculation to get full credit ii. Are A's and B's consumptions of cigarettes elastic or inelastie? Whom you think is the occasional smoker and who is the regular smoker (that is, dependent on smoking)? Explain clearly in 2 or more sentences. b) Suppose that for a consumer C the price elasticity of demand for cigarettes is equal 1.5. How big will the increase in cigarettes consumed be following a 16 percent decrease in cigarettes' prices? Show all the steps of your calculation to get full credit. c) If you are a seller of cigarettes and you sell in 2 different markets, but you realize that when you lower your price by 24%, your quantity sold are increased by 8% in one market and by 36% in the other market, in which market would your total revenue increase or decrease? Explain, that is, show all the steps that lead to your conclusion.

Explanation / Answer

a)

i) price elasticity of demand = %change in demand/%change in price

price elasticity of demand for A = 6/20 = 0.3

price elasticity of demand for B= 30/20 = 1.5

ii) A's consumption is inelastic.

B's consumption is elastic.

A is regular smoker because his demand for cigarrette is not much dependent on price.

B is occassional smoker because his demand for cigarrette is very much dependent on price.

b.) %change in demaand = price elasticity of demand *%change in price

%change in demand for C= 1.5*16 = 24

C will increase demand for cigarrette by 24% with 16% decrease in price.

c)

marginal revenue, MR=P*(1-1/price elasticity of demand)

for market 1, MR=P(1-24/8) = -2P

for market 2, MR=P(1-24/36) = P/3

For market 2, MR is positive so revenue wil increase.

For market 1, MR is negative so revenue wil decrease.

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