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Applications of the Price Elasticities

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1.- The price elasticity of demand for imported whiskey is estimated to be -0.20 over a wide interval of prices. The federal government decides to raise the import tariff on foreign whiskey, causing its price to rise by 20%. Will sales of whiskey rise or fall, and by what percentage amount?

2.- In an article about the financial problems of the USA today, Newsweek reported that the paper was losing about $20 million a year. A Wall Street analyst said that the paper should raise its price from .50 to .75, which he estimates would bring in an additional 65 million a year. The paper's publisher rejected the idea, saying that the circulation could drop sharply after the price increase, citing that the wall street journal's experience after it increased its price to .75.What implicit assumptions are the publisher and the analyst making about price elasticity?

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Solution Summary

There are two problems. Solution to first problem predicts the change in sales of whiskey as a result of raise in import tariff. Solution to second problem lists the assumptions made by analyst and publisher about price elasticity of demand of news paper.

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1. Price elasticity of demand for imported whiskey=Ep=-0.20
Change in price=+20% (positive sign indicates an increase in prices)
Change in demand=Change in sales of imported whiskey=Ep*change in prices=-0.20*20%=-4%
Negative sign indicates fall in sales. Sales of imported whiskey will fall by 4%.

2. ...

Solution provided by:
Lokesh Jain, MSc
Education
  • BEng (Hons) , Birla Institute of Technology and Science, India
  • MSc (Hons) , Birla Institute of Technology and Science, India
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