Suppose that the local utility regulators have recently approved an increase in the price of electricity from 10¢ per kilowatt-hour to 10.5¢ per kilowatt-hour. The long-run price elasticity of demand for electricity is estimated to be -1.2.
(i) By how much will the quantity demanded of electricity drop in the long run because of this price increase?
(ii) When the price of electricity increases, will consumers' total expenditures on electricity rise or fall in the long run? (Hint-Consider which is larger, the percentage increase in price or the percentage decrease in quantity demanded.)
(iii) The cross elasticity of demand for electricity with respect to natural gas is 0.2. By how much would the price of natural gas have to change to totally offset the effect that the price increase in electricity has on the quantity of electricity consumed? In other words, by how much would the price of natural gas have to change to cancel out the fall in the quantity demanded that you calculated in part i?
(i) The price rises by 5%, so the quantity demanded falls by 1.2 ? 5% or 6%.
(ii) Consumers' total expenditures equal the price they pay times the quantity they purchase. The rise in price (5%) is more than offset by the fall in quantity demanded (6%), so consumers' total expenditures must fall.
(iii) The price of natural gas must rise by 6% ÷ 0.2 or 30%.
You might also like to view...
According to data on Pennsylvania agriculture in the 18th century, increases in productivity were primarily due to:
a. increases in average farm size. b. increases in the amount of labor per farm. c. decreases in the land-labor ratio d. increases in the capital-labor ratio.
The real balance effect (wealth effect), the interest rate effect, and the net exports effect all help to explain the:
a. decrease in supply in the loanable funds market. b. large federal budget deficit. c. increase in short-run aggregate supply. d. downward-sloping aggregate demand curve.
Investment spending in the United States tends to be unstable because:
A. expected profits are highly variable. B. capital goods are durable. C. innovation occurs at an irregular pace. D. all of these contribute to the instability.
Related to the Economics in Practice on page 316: From a consumer welfare standpoint, as the variety of available choices of a particular type of product increases, consumer welfare
A. increases at a proportional rate. B. decreases at a proportional rate. C. tends to remain very constant. D. increases to a point, but eventually may lose value with too much variety.