Problem Set 2

  1. Imagine you are the manager of the public transit system in your town. Your finance officer has just advised you that the system faces a deficit. Your board doesn’t want you to cut service, which means that you can’t cut costs. Your only hope is to increase revenue. You have to decide whether a fare increase will boost revenue. You consult the economist on your staff who has researched studies on public transportation elasticities. She reports that the estimated price elasticity of demand for the first few months after a price change is about –0.5, but that after several years, it will be about –1.5.
  2. Explain why the estimated values for price elasticity of demand differ.
  3. Compute what will happen to ridership over the next few months if you decide to raise fares from $.85 to $.95.
  4. Compute what will happen to ridership over the next few years if you decide to raise fares from $.85 to $.95.
  5. What happens to total revenue now and after several years if you choose to raise fares?
  1. Are there any times when the price elasticity of demand is positive? Consider the following questions.
  2. The advertising slogan of Maker Mark’s Whiskey is: “It tastes expensive … and it is.” Isn’t the firm foolish to advertise its high price? Or will people buy more if they think Maker Mark’s is more expensive than other whiskeys? If so, does this contradict the law of demand?
  3. A waiter at a swank restaurant says, “It is good to be known as expensive. People know they can impress their guests here.” What does he think people are purchasing when they go to this restaurant for dinner?
  1. During World War II, there was a freeze on wages, and employers found that they could evade the limit by providing non-salary benefits, particularly employer-paid (and therefore untaxed) health-care insurance. The IRS has allowed the benefits (with some exceptions) to remain untaxed ever since. Employer-based health insurance was thus an unintended consequence of wage controls that were in effect during WWII. Are wage controls and example of a price ceiling or a price floor? Use the tools of demand and supply to explain why employers at the time might have begun to offer health insurance to their employees.
  1. Internet problem: Using the Internet, discuss the current status of minimum wage legislation in the Congress in a short essay. Who are some of the proponents of minimum wage increases and who is opposed to such increases? Be sure to tell me which site(s) you used to answer this question.