1. City planners are proposing a 5% increase in all water rates. Prior to adopting this policy, the city council would like to receive information about the effects on consumers and the water department. We can rough out some quick and useful estimates using knowledge of an annual demand point and the price elasticity of demand (remember the point expansion method). Suppose the water department delivers 180 million gallons per year while taking in $740,000 in revenue per year. Of this revenue, $520,000 is derived from volumetric (metered) charges, and the remainder comes from fixed fees such as monthly charges and late fees. Assume that the price elasticity of water demand is -0.3. (a) How much will the consumers' total welfare change? Hints: • Remember the point expansion method, where using the elasticity and a point from on the demand curve, we can reclaim the entire demand equation. • Assume a linear demand curve. • Remember the elasticity formula: dw P dp w Note that this utility charges two kinds of costs. One as fixed fees and one in the form of volumetric price. Also remember that the demand function is the relationship between the *marginal* price and the quantity demanded. Construct your demand curve with this in mind. • Once you construct the demand curve what is the new quantity demanded under the new *marginal* price? Now find the welfare change. Think "area under some curve". (b) How much will the utility's revenue change?
1. City planners are proposing a 5% increase in all water rates. Prior to adopting this policy, the city council would like to receive information about the effects on consumers and the water department. We can rough out some quick and useful estimates using knowledge of an annual demand point and the price elasticity of demand (remember the point expansion method). Suppose the water department delivers 180 million gallons per year while taking in $740,000 in revenue per year. Of this revenue, $520,000 is derived from volumetric (metered) charges, and the remainder comes from fixed fees such as monthly charges and late fees. Assume that the price elasticity of water demand is -0.3. (a) How much will the consumers' total welfare change? Hints: • Remember the point expansion method, where using the elasticity and a point from on the demand curve, we can reclaim the entire demand equation. • Assume a linear demand curve. • Remember the elasticity formula: dw P dp w Note that this utility charges two kinds of costs. One as fixed fees and one in the form of volumetric price. Also remember that the demand function is the relationship between the *marginal* price and the quantity demanded. Construct your demand curve with this in mind. • Once you construct the demand curve what is the new quantity demanded under the new *marginal* price? Now find the welfare change. Think "area under some curve". (b) How much will the utility's revenue change?
Chapter1: Making Economics Decisions
Section: Chapter Questions
Problem 1QTC
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Transcribed Image Text:1. City planners are proposing a 5% increase in all water rates. Prior to adopting this policy, the city
council would like to receive information about the effects on consumers and the water department.
We can rough out some quick and useful estimates using knowledge of an annual demand point
and the price elasticity of demand (remember the point expansion method). Suppose the water
department delivers 180 million gallons per year while taking in $740,000 in revenue per year. Of
this revenue, $520,000 is derived from volumetric (metered) charges, and the remainder comes from
fixed fees such as monthly charges and late fees.
Assume that the price elasticity of water demand is -0.3.
(a) How much will the consumers' total welfare change? Hints:
• Remember the point expansion method, where using the elasticity and a point from on the
demand curve, we can reclaim the entire demand equation.
• Assume a linear demand curve.
• Remember the elasticity formula:
dw P
dp w
• Note that this utility charges two kinds of costs. One as fixed fees and one in the form of
volumetric price. Also remember that the demand function is the relationship between the
*marginal* price and the quantity demanded. Construct your demand curve with this in
mind.
• Once you construct the demand curve what is the new quantity demanded under the new
*marginal* price?
• Now find the welfare change. Think "area under some curve".
(b) How much will the utility's revenue change?
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