Quiz 20: Consumer Choice and Elasticity

Business

(a) Revenue will rise if the price elasticity of demand for the courses at NSU is elastic. This happens because when a commodity has elastic demand, rise in its price results in an increase in consumer's total expenditure or a firm's total revenue. (b) Revenue will fall if the price elasticity of demand for the courses at NSU is inelastic. This happens because when a commodity has inelastic demand, rise in its price results in decrease in consumer's total expenditure or a firm's total revenue. (c) Revenue will remain same if the price elasticity of demand for the courses at NSU is unit elastic. This happens because when a commodity has unit elastic demand, rise or fall in price of commodity does not bring any change in consumer's total expenditure or firm's total revenue. If the true price elasticity is - 1.2 then this implies that price elasticity of demand is approximately unit elastic. When demand for a commodity is unit elastic, any change in price (either increase or decrease) will not have any impact on the total revenue to be earned by the producers. So, NSU will not be able to increase its revenue by increasing its tuition as demand for its courses is unit elastic. In such scenario, instead of increasing tuition, it should look for other ways to expand revenue such as introducing more employment oriented courses etc.

Journey by bus cost $50 but takes 28 hours whereas journey by airplane costs $300 and takes 3 hours. Difference between the cost of bus ticket and airplane ticket is $250. Mary values her time at $12 per hour. If Mary takes the airplane instead of bus she will save 25 hours. Total time cost saved is ($12 × 25 hours) $300. Since, Mary's saving of time cost is more than the difference between the cost of bus ticket and airplane ticket she will take the plane for journey. Michele values her time at $8 per hour. If Michele takes the airplane instead of bus she will save 25 hours. Total time cost saved is ($8 × 25 hours) $200. Since, Michele's saving of time cost is less than the difference between the cost of bus ticket and airplane ticket she will take the bus for journey.

When price of cigarettes increases then two things happens, firstly cigarettes become more expensive in relation to its substitutes and consumer's real income contracts. If we compare on basis of income levels then this contraction in real income is much more in case of low-income consumers than in case of high income consumers. Due to larger impact of income effect and that also in adverse manner low - income consumers compelled to reduce their purchase of cigarettes, but as addiction to nicotine is very difficult to get rid of, these consumers will look for cheaper substitutes so that they can have their daily fill of nicotine, and thus increase their purchase of substitute goods like nicotine gum, electronic cigarettes etc. On the other hand, high income consumers will have small impact of rise in price of cigarettes on their real income, and thus do not reduce their consumption as drastically as is done by the low-income consumers. As they reduce their consumption in very small manner they would not be looking actively for substitute products, or even if they look for substitutes, they will purchase a small quantity. So, on account of higher impact of both income effect and substitution effect on the low income consumers, they reduce their quantity purchased of cigarettes in much larger quantity when its price rise in comparison to high income consumers.

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