Question 1: (30 points) When the Linda had a monthly income of $4,000, they usually ate out 8 times a month. Now that the couple makes $4,500 a month, they eat out 10 times a month.

Compute the couple's income elasticity of demand using the midpoint method. Explain

your answer. Is a restaurant meal a normal or inferior good to the couple?

Question 2: (40 points) The following table lists the cross-price elasticities of demand for several goods.

	Cross-Price Elasticities of Demand
Air-conditioning units and kilowatts of electricity	- 0.34
Coke and Pepsi	+ 0.63
High-fuel-consuming sports utility vehicles and gasoline	- 0.28
McDonald's burgers and Burger King burgers	+ 0.82
Butter and Margarine	+ 1.54

a) Explain the sign of each of the cross-elasticities. What does it imply about the

relationship between the two goods in question?

b) Compare the absolute values of the cross-elasticities and explain their magnitudes. For

example, why is the cross elasticity for McDonald's with Burger King less than the

cross elasticity for butter with margarine?

c) Use the information above to calculate how a 5% increase in the price of Pepsi affects

the quantity demanded of Coke.

d) Use the information above to calculate how a 10% fall in the price of gasoline affects

the quantity of high-fuel-consuming SUVs demanded.

Question 3: (30 points) TheNile.com, the online bookseller, wants to increase its total revenue. Currently, every book they sell is priced at $10.50. One suggested strategy is to offer a discount which

lowers the price of a book to $9.50, a 10% reduction in price using the midpoint method.

TheNile.com knows that its customers can be divided into two distinct groups according to

their likely responses to the discount. The following table shows how the two groups,

called Group A and Group B, respond to the discount.

	Group A Sales per Week	Group B Sales per Week
Volume of sales before the 10% discount	1.55m	1.50m
Volume of sales after the 10% discount	1.65m	1.70m

1. Using the midpoint method, calculate the price elasticities of demand for group A and group

1. Explain how the discount will affect total revenue from each group.

1. TheNile.com knows which group each customer belongs to as he or she logs on and can

choose whether or not to offer the 10% discount. Should discounts be offered to Group

A or to Group B, to neither group, or to both groups?