Question 1 -
(a) Consider the market for air travel. It is discovered that the demand for business class ticket is relatively more inelastic compared to the demand for economy class ticket.
(i) Assume that initially the equilibrium price and quantity of tickets for both classes are the same. Use a market diagram for air travel which illustrates both the business class and the economy class.
(ii) An improvement in the technology of air travel has occurred which affects both classes equally. Draw a suitable diagram to illustrate and discuss the effect on the equilibrium price and quantity of business class and economy class tickets. From the diagram, explain which class has a larger change in price and which class has a larger change in quantity after the technological improvement.
b) Evaluate the following statements and discuss whether they are true, false or uncertain. Justify your answers.
(i) A monopolist encounters a linear demand curve should always produce at the point where the demand is unit elastic in order to maximise profit.
(ii) Applying the rational spending rule, a consumer consuming two products A and B should always buy more A and less B if the marginal utility of the last unit of A consumed is higher than that of B.
Question 2 -
(a) An airline offering flight services from Singapore to Bangkok, Thailand, has two classes of seats, business class and economy class. Due to the higher oil prices, the airline has increased the ticket prices for both classes. The prices and tickets sold for both classes before and after the price hike is shown in the table below.
|
Economy Class
|
Business Class
|
|
Price
|
Tickets Sold
|
Price
|
Tickets Sold
|
|
$300
|
280
|
$2000
|
50
|
|
$450
|
120
|
$3000
|
40
|
(i) Calculate the price elasticity of demand for both classes using the mid-point formula.
(ii) Given that the income elasticity of demand for economy class ticket is 1.5 and the cross elasticity of demand between economy class quantity and high speed rail price is 1.2, other things equal, explain the impact on the economy class revenue if income of consumers increase by 5% and high speed rail price decreases by 8%. Analyse each incident separately.
(b) The following table shows the total cost incurred by a perfectly competitive firm in the short run.
|
Output
|
Total Cost
|
|
0
|
10
|
|
1
|
16
|
|
2
|
20
|
|
3
|
22
|
|
4
|
23
|
|
5
|
26
|
|
6
|
36
|
|
7
|
48
|
|
8
|
61
|
|
9
|
81
|
|
10
|
106
|
(i) Describe the relationship between total cost and average cost. Calculate the average fixed cost at 4 units of output, the average variable cost at 5 units of output the average total cost at 6 units and the marginal cost at the 7th units of output.
(ii) Assume that the firm is able to sell any amount of its output at the price of $10 per unit. Explain how to determine the optimal quantity and calculate the total profit or loss at that quantity.