Conside r the markets for mobile and landline telephone service. Suppose that wh

Question

Consider the markets for mobile and landline telephone service. Suppose that when the average income of residents of Plainville is $55,000 per year, the quantity demanded of landline telephone service is 12,500 and the quantity demanded of mobile service is 28,000. Suppose that when the price of mobile service falls from $120 to $100 per month, the quantity demanded of landline service decreases to 11,000. Suppose also that when the average income increases to $60,000, the quantity demanded of mobile service increases to 33,000.

#3: (15 pts) Using the midpoint method, what is the income elasticity of demand for mobile service? Considering the income elasticity, what type of good is mobile telephone service?

#4. (15 pts) Using the midpoint method, what is the cross price elasticity of demand for landline and mobile service? Considering the cross price elasticity of demand for mobile and landline telephone service, is the cross price elasticity of demand positive or negative and do the consumers of Plainville regard these goods as substitutes or complements?

Explanation / Answer

3.

I1 = $55000          I2 = $60000                          D1 = 28000          D2 = 33000

Income elasticity of demand for mobile services = % change in demand / % change in income

As per the midpoint method,

Income elasticity of demand for mobile services = ((D2 – D1) / ((D1+D2)/2))) / ( (I2-I1)/((I1+I2)/2)))

Income elasticity of demand for mobile services = ((33000 – 28000) / ((33000+28000)/2)) / ((60000-55000)/((60000+55000)/2))

Income elasticity of demand for mobile services= 1.885

Since income elasticity of demand is positive and greater than 1 then mobile telephone service is considered as superior or luxury goods.

4.

P1 = $120             P2 = $100             D1 = 12500          D2 = 11000

Cross elasticity of demand measures the percentage change in demand of good A due to percentage change in price of good B.

Cross elasticity of demand = % change in demand of landline service / % change in price of mobile services

As per midpoint formula

% change in demand of landline service = (D2-D1) / ((D2+D1)/2) = (11000 -12500)/((11000+12500)/2)

% change in demand of landline service = -.1276

% change in price of mobile services = (P2-P1) / ((P2+P1)/2) = (100 -120)/((100+120)/2)

% change in price of mobile services = -.1818

Cross elasticity of demand = -.1276 / -.1818 = .702

Cross elasticity of demand is positive. It shows that both the services are substitute to each other as decrease in price of mobile services increases the demand of mobile services and it reduces the demand of landline service as mentioned by the data in problem.

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