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3) (8 points) Suppose you work for the Wisconsin Milk Marketing Board and you are interested in determining the structure of the market demand for
3) (8 points) Suppose you work for the Wisconsin Milk Marketing Board and you are interested in determining the structure of the market demand for a unique aged cheddar cheese made only in Wisconsin. You want to do this to evaluate how sensitive consumers of this cheese are to changes in price and to assist Wisconsin cheesemakers in determining their optimal pricing point. You collect the necessary sales data and you estimate a statistical model showing the relationship between market price and the amount of this special aged cheddar cheese (measured in 1,000 lbs) sold monthly. This demand relationship is shown in Figure 1 below. The current market price is $7.00/lb and 150,000 Ibs was sold last month at that price. Market Demand For Wisconsin Aged Cheddar Cheese 10,00 3.00 150 225 Thousand Lba. a) [4 pts] Next year a new cheese plant will come on-line and will dramatically increase the capacity of the aged cheddar industry in Wisconsin. This increase in supply is anticipated to cause the market price to decrease to $3.00/lb and your estimate is that the monthly amount of cheese that will be sold at this new price will be 225,000 lbs. i. Use the total revenue test and show whether demand is price elastic or inelastic.ii. What is your estimate of the age-cheddar cheese price elasticity of demand, given the above information? Use the formula from class to obtain the above elasticity estimate. b) [4 pts] Suppose the cheese industry is producing now at point B and the income elasticity for Wisconsin aged cheddar is .5. As part of his tax plan President Biden would like to enact a reduction in payroll taxes that results in an average increase in disposable income of 10%. i. Is aged-cheddar a normal good or inferior good? How do you know? ii. As a result of this increase in income due to the lower tax, what would be the new amount of cheese sold given that the market price remains unchanged at the current market price of $3.00/lb ? Show how you obtained your result
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