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# UNIVERSITY OF MELBOURNE

DEPARTMENT OF ECONOMICS

Semester 2, 2018

## Tutorial Exercise 3: Elasticity and applications

KEY CONCEPTS:
Elasticity
Own-Price elasticity of demand
Measurement of elasticity
Arc and Point Elasticity
Cross-price elasticity of demand
Income elasticity of demand
Own-price elasticity of supply
Indirect tax
Tax incidence

## Refer to Tutorial Exercise 2, Task 2(d).

Say whether each of the following statements is correct or incorrect. Explain your

a) Food and clothing are necessary goods. Hence, demand for those goods will show
a greater degree of responsiveness to price (higher own-price elasticity) than for
other goods such as attendance at sporting events or music concerts.

b) Demand for motor vehicles exhibits positive income elasticity. This means that
there are no close substitutes for motor vehicles.

c) Over a relatively short time horizon, the demand for petrol is likely to be inelastic
with respect to price. But over the longer term, as motor vehicle owners have the
scope to change to other types of fuel such as natural gas, demand for petrol will
be more elastic with respect to price.

1

Suppose that business travellers and holiday-makers have the following demand
schedules for air tickets for travel from Melbourne to Sydney:

## Quantity Demanded Quantity Demanded

Price (\$)
100 2300 1750
200 2100 1250
300 1900 750
400 1700 500

a) Suppose the price increases from \$200 to \$300. What is the (arc) own-price
elasticity of demand for: (i) business travelers; and (ii) holiday makers?

## b) Why might holiday makers have a different own-price elasticity of demand to

Consider the following demand and supply schedule for chocolate bars.

## Price Quantity Demanded Quantity Supplied

(cents per bar) (bars) (bars)
90 100 160
80 110 150
70 120 140
60 130 130
50 140 120
40 150 110
30 160 100

## b) Suppose the government imposes a tax of 20 cents on the production of each

chocolate bar. What is the price paid by consumers, the price received by
producers, and the quantity of chocolate bars sold? What is the difference between
the price paid by consumers and the price received by producers? Has the quantity
of chocolate bars sold increased or decreased? Illustrate with a supply and
demand curve diagram.

c) How much of the tax is paid by the consumer and how much by the producer?
What is the amount of tax revenue collected by the government?

d) Suppose the price elasticity of demand was perfectly elastic, while supply is
relatively price inelastic. Who bears a greater burden of the tax, consumers or
producers? Illustrate with a supply and demand curve diagram. Explain.

2

Dan and Sue are discussing the recent seizure by police in Sydney of 240 kilograms
of cocaine smuggled into the country from Mexico, and the detrimental effects of the
drug on the health and welfare of young people.

Dan says: “The most effective way to reduce the consumption of cocaine is to increase
the number of customs inspectors and police officers devoted to preventing the
imports of cocaine. This would reduce the availability of cocaine on the Australian
market.”

Sue disagrees and says: “A more effective policy would be to launch a national
educational campaign warning young people about the health risks associated with
the use of cocaine.’:

Assume that the demand for cocaine is inelastic and the supply of cocaine is elastic.