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Chapter 6: Problem 9

Consider firms selling three goods: Firm A sells a good with an income elasticity of demand less than zero; Firm B sells a good with an income elasticity of demand greater than zero but less than one; and Firm \(C\) sells a good with an income elasticity of demand greater than one. In a recession when incomes fall, which firm is likely to see its sales decline the most? Which firm is likely to see its sales increase the most? Briefly explain.

Short Answer

Expert verified
Firm \(A\) is expected to see an increase in sales due to it selling inferior goods, the demand for which rises as income falls. Firm \(B\)'s sales might mildly lower given that it sells necessary goods. Firm \(C\) would likely face the most prominent sales decline due to it selling luxury goods, the demand for which highly shrinks when incomes drop.

Step by step solution

01

Norm Analysis

Firstly, catalog each firm on the grounds of elasticity of demand. Firm \(A\) has an income elasticity of demand less than zero indicating it sells an inferior good. Firm \(B\) has elasticity greater than zero but less than one, implying it sells a normal but necessary good. Firm \(C\) also sells a normal good but it is interpreted as a luxury because an elasticity greater than one denotes that.
02

Recession Impact on Firm \(A\)

During a recession, people's incomes fall. For inferior goods, as income decreases, the demand increases. Hence, Firm \(A\) is likely to see an increase in its sales.
03

Recession Impact on Firm \(B\)

As for Firm \(B\), it sells a necessary good, the demand of which mildly depends on income changes. But since in a recession income decreases, the sales could see a slight decrease as well.
04

Recession Impact on Firm \(C\)

Firm \(C\) sells luxuries that have high income elasticity of demand. In a recession, as income falls, the demand for these goods falls sharply. Therefore, Firm \(C\) is expected to witness the greatest decline in sales.

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Most popular questions from this chapter

An article in the New York Times about the New York Metropolitan Opera (the Met) suggested that the popularity of opera might be increased if the Met reduced its ticket prices. But the article observed that such ticket price cuts would be possible only if the Met received a gift from "a very deep- pocketed donor." What were the authors of the article assuming would happen to the Met's revenue following the cut in ticket prices? What were they assuming about the price elasticity of demand for tickets to the Met? Briefly explain.

In recent years, increases in the number of visitors to national parks such as Yellowstone and Grand Canyon have resulted in over \(\$ 12\) billion in deferred maintenance costs. In response to the overcrowding that has contributed to the cost overruns, the Park Service has considered limiting the number of daily visits to the parks and soliciting corporate sponsorships. Margaret Walls, a research director and senior fellow at Resources for the Future, has offered another suggestion: Increase entrance fees. But she warned: "Figuring out an efficient and fair fee structure will not be easy. It requires detailed data on visitation, for starters, as well as analysis to shed light on price elasticities of demand for different groups of visitors at different locations." Why is it important for the Park Service to have estimates of price elasticities of demand before raising entrance fees to the national parks?

The publisher of a magazine gives her staff the following information: $$ \begin{array}{l|l} \hline \text { Current price } & \$ 2 \text { per issue } \\ \hline \text { Current sales } & 150,000 \text { copies per month } \\ \hline \text { Current total costs } & \$ 450,000 \text { per month } \\ \hline \end{array} $$ The publisher tells the staff, “Our costs are currently \(\$ 150,000\) more than our revenues each month. I propose to eliminate this problem by raising the price of the magazine to \(\$ 3\) per issue. This will result in our revenue being exactly equal to our cost." Do you agree with the publisher's analysis? Explain. (Hint: Remember that a firm's revenue is calculated by multiplying the price of the product by the quantity sold.)

A study of consumers in Mexico found that the cross-price elasticity of demand between soda and milk was 0.11 , while the cross-price elasticity of demand between soda and candy was -0.32 . Is soda a substitute or a complement for milk? Is soda a substitute or a complement for candy? Briefly explain.

What are the key determinants of the price elasticity of demand for a product? Which determinant is the most important?
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