Question

Individuals differ in their willingness to pay for air travel, and airlines would like to charge different prices to different individuals based on their willingness to pay. Airlines typically attempt to divide passengers into two types: leisure travelers and business travelers. Suppose that an airline is charging $400 per ticket for all passengers on flights between New York and Washington D.C. The accompanying tables provide information on quantity demanded for air travel for leisure travelers and business travelers.

Price
(per ticket) Quantity‑leisure travelers
(tickets per flight)
$400 100
$500 50


Price
(per ticket) Quantity‑business travelers
(tickets per flight)
$400 100
$500 90

a. What is the absolute value of price elasticity for leisure travelers if the airline increases the price to $500? Round your answer to the nearest whole number.

b.What is the change in total revenue for leisure travelers when the price increases to $500?

c. What is the absolute value of price elasticity for business travelers if the airline increases the price to $500? Round your answer to the hundredths place.

d. What is the change in total revenue for business travelers when the price increases to $500?

e. To maximize total revenue, the airline should charge
$400 to leisure travelers and $500 to business travelers.
$500 to both groups.
$400 to both groups.
$500 to leisure travelers and $400 to business travelers.

Answer 1

The price elasticity of demand for leisure travellers is 2.

The change in total revenue for leisure travellers is $-15,000.

The price elasticity of demand for business travellers is 0.4.

The change in total revenue for business travellers is $5000.

To maximize total revenue, the airline should charge $400 to leisure travelers and $500 to business travelers.

What is the price elasticity of demand?

Price elasticity of demand measures the responsiveness of quantity demanded to changes in price of the good.

In order to maximise total revenue, the party with the less elastic demand should be charged the higher price and the party with the more elastic demand should be charged the lower price .

Price elasticity of demand = percentage change in quantity demanded / percentage change in price

Price elasticity of demand for leisure travellers:

• Percentage change in price = ($500 / $400) - 1 = 25%
• Percentage change in quantity demanded = (50 / 100) - 1 = -0.5 = -50%
• Price elasticity of demand = -50%  25% = 2

Price elasticity of demand for business travellers:

• Percentage change in price = ($500 / $400) - 1 = 25%
• Percentage change in quantity demanded = (90 / 100) - 1 = -0.1 = -10%
• Price elasticity of demand = -10% / 25% = 0.40

What is the change in total revenue?

• Change in total revenue for leisure travellers = ($500 x 50) -  ($400 x 100) = $-15,000
• Change in total revenue for business travellers = ($500 x 90) -  ($400 x 100) = $5000

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