8.

If Congress levies an additional tax on luxury items, the prices of these items
will rise. However, this will cause demand to decrease, and as a result the
prices will fall down, perhaps even to their original levels. Do you agree or
disagree with this statement? Please explain.
I agree with the statement. The reason is because luxury items are price
elastic meaning which a change in price leads to a bigger % change in
demand; therefore the Price Elastic of Demand (PED) will therefore be
greater than 1. With the increase of price of these products, demand
would likely to decrease as this goods have many substitutes and a very
competitive market. In addition, there be a decline in income then the
demand will drop. E.g. if Hermes put up the price of its handbag there are
many alternatives, so people would be price sensitive.
17. A travel company has hired a management consulting company to analyze
demand in twenty-six regional markets for one of its major products: a guided
tour to a particular country. The consultant uses data to estimate the following
equation (the estimation technique is discuss in detail in chapter 5):
Q = 1,500 - 4P + 5A + 10I + 3PX
Where;
Q = amount of the product demanded
P = price of product in dollars
A = advertising expenditure in thousands of dollars
I = income in thousands of dollars
PX = price of some other travel products offered by a competing travel
company.
a. Calculate the amount demanded for this product using the following data:
P = $400
A = $20,000
I = $15,000
PX = $500
Answer: Q = 1,500 4(400) + 5(20) + 10(15) + 3(500) = 1,650 units
b. Suppose the competitor reduced the price of its travel product to $400 to
match the price of the firms product. How would this firm have to increase
its advertising in order to counteract the drop in its competitors price?
Would it be worth it for them to do so? Explain.
Q = 1,500 4(400) + 5A + 10(15) + 3(400) = 1,650 units
5A + 1,250 = 1,650
5A = 1,650 1,250
5A = 400
A = 400/5
A = 80

New level of advertisement required to maintain quantity demanded.

This firm has to increase advertisement cost to another $60,000.
Is it worth?
Profit:
= P x Q Total Cost
= [$400 x 1650] - $60,000
= $660,000 $80,000
= $520,000
Yes, it is it is worth for them to do so as the companies are still
profitable.
c. What other variables might be important in helping estimate the demand
for this travel product?
Anything is possible but need to differentiate between theoretically
plausible factors and statistically plausible factors.
For theoretically plausible factors, they can be anything between
earth and sky.
For statistical consideration, the factor can vary in score/value with
regards to different region. Otherwise, statiscally, the whole model
cannot be estimated due to multicollinearity problem.