Price Elasticity

The Board of trustees of a leading state university is faced with a critical financial
problem. At Present tuition rates, the University is losing $ 7.5 million per year. The
President of the University urges that tuition be raised $750 over the present
$3000 rate- a 25% increase. Based on the 10000 students now attending the
school, he projects that this increase would cover the $7.5 million shortfall in
revenues.
Student leaders protest that they cannot afford a tuition hike; the president
responds that the only alternative is cut back significantly on programs and faculty.
The faculty supports the tuition increase as a means of preserving their jobs.
The students quickly realize that any appeal that involves compassion for their
plight is likely to fall on deaf ears. Their only hope is to demonstrate that the
tuition hike is not in the best interest of the university.
(A journal articles reveals that the elasticity for enrollment at state university is – 1.3 with respect to the
tuition charges)

1. How the students can convince the management that the fee hike is not the
best course of action to increase the revenue?
 Elasticity of demand
The XL Books Ltd.is a publisher of novels. The corporation hires an
economist to determine the demand for its product. After months of hard
work and submission of an exorbitant bill, the analyst tells the company
that demand for the firm’s novels (Qx) is given by the following equation
Qx =12,000 -5,000Px +5Y +500Pc

Where Px is the price charged for the Hind Books novels ,Y is income per
capita , and Pc is the price of books from competing publishers .
Assume that the initial values of Px , Y and Pc are Rs. 5, Rs.10,000 and rs.6 respectively
You being a manager ,using this information, address the following:
1. Determine what effect a price increase would have on Total revenues
2. Evaluate how sale of the novels would change during a period of raising
incomes
3. Assess the probable impact if competing publishers raise their prices
 Price Elasticity of demand
• The IPL team plays in a stadium with a average
seating capacity of 180000. However, during
the past season, attendance averaged only
150000. The average ticket price was Rs.3000.
If the price elasticity is -5, what price would
the Stadium has to charge in order to fill the
stadium?
• Caterpillar Tractor, one of the largest
producers of farm machinery in the world, has
hired you to advise it on pricing policy. One of
the things the company would like to know is
how much a 5 % increase in price likely to
reduces sales. What would you need to know
to help the company with this problem?
Explain why these facts are important?
Suppose that a study has found that the price
elasticity of demand for flyover rides is 0.7 in
Bangalore Electronic city to Silk Board junction.
The company wants to cut the operating deficit
of the Elevated Highway System. Should the
manager contemplate increasing or decreasing
the price of a flyover ride? Explain the
importance of price elasticity of demand in
pricing decision.
• Vera has decided to upgrade the operating system on
her new PC. She heard that the new Linux operating
system is technologically superior to Windows and
substantially lower in price. However, when she asks
her friends, it turns out that they all use PCs with
Windows. They agree that Linux is more appealing
but add that they see relatively few copies of Linux
on sale at local stores. Vera chooses Windows. Can
you explain her decision?
• A certain town in Kerala obtains all of its electricity
from one company, South Electric. Although the
company is a monopoly, it is owned by the citizens of
the town, all of whom split the profits equally at the
end of each year. The CEO of the company claims
that because all of the profits will be given back to
the citizens, it makes economic sense to charge a
monopoly price for electricity. True or false? Explain.
 Elasticity of Demand
Current demand for apples in a city is 1000
boxes per week. In the city, price elasticity of
demand for apples is –1.25 and income
elasticity of demand is 2.00. For the next
period, if per capita income is expected to
increase by 7% and price of apples is expected
to increase by 10%.
What would be the expected demand for
apples ?
 Elasticity of demand
• Alok, a premier toy manufacturer, recorded an
increase sales by 10 percent. During the year,
Alok reduced the prices by 10 percent. Per capita
income in the economy increased by 2.5 percent
and the competitor, Blok, reduced the prices of
his toys by 5 percent. Income elasticity of
demand for the toys is estimated to be 2 and
cross-price elasticity between Alok toys and Block
toys is estimated to be 0.5. Given the situation,
what is the price elasticity of demand for toys?
 Elasticity of Demand
• In a year, the number of motor vehicles sold
decreased by 25%. During the year, the price
of motor vehicles increased by 7.5%, per
capita income decreased by 3% and the price
of petrol increased by15%. Income elasticity of
demand for motor vehicles is estimated to be
+2 and cross price elasticity of petrol and
motor vehicles is estimated to be –0.25.
Calculate the impact of increase in price of
petrol on the demand for cars.
• Suppose that you are the consultant to an agricultural
cooperative that is deciding whether members should
cut their production of cotton in half next year. The
cooperative wants your advice as to whether this
action will increase members’ revenues. Knowing that
cotton (C) and watermelons (W) both compete for
agricultural land in the South, you estimate the
demand for cotton to be
• C = 3.5 – 1.0PC + 0.25PW + 0.50I,
• where PC is the price of cotton, PW the price of watermelon, and I income.
Should you support or oppose the plan? Is there any
additional information that would help you to
provide a definitive answer?
• If production of cotton is cut in half, then the price of cotton will increase, given that we
• see from the equation above that demand is downward sloping. With price increasing
• and quantity demanded decreasing, revenue could go either way. It depends on
• whether demand is elastic or inelastic. If demand is elastic, a decrease in production
• and an increase in price would decrease revenue. If demand is inelastic, a decrease in
• production and an increase in price would increase revenue.
• You need a lot of
• information before you can give a definitive answer. First, you must know the current
• prices for cotton and watermelon plus the level of income; then you can calculate the
• quantity of cotton demanded, C.
• Next, you have to cut C in half and determine the
• effect that will have on the price of cotton, assuming that income and the price of
• watermelons are not affected (which is a big assumption). Then you can calculate the
• original revenue and the new revenue to see whether this action increases members’
• revenues or not.