1) Since the 1973-1974 Arab oil embargo, the price of gasoline and diesel fuel in France has almost tripled to the equivalent of $3.17/gallon. Gasoline and diesel fuel consumption were (each) up by 21% over 1973. As gasoline prices were rising, so were hourly wages at about 15% a year since 1973 (15% per year for each of six years between 1973-1979). In France, gasoline consumption increases about one percent with each percentage increase in consumer income, and the population of France changed very little over the 1974-1979 time period. Automobile prices in France changed very little over this period. Suppose that someone has calculated the "price elasticity of demand" for gasoline by implicitly dividing the percentage change in consumption (21%) by the percentage change in price (200%) and arrived at a positive number for the price elasticity of demand for gasoline.
a) Re-calculate the price elasticity of demand for gasoline taking into account only the additional information on changes in hourly wages.
b) If you found out that the cross elasticity of demand between gasoline and diesel fuel in France was about 0.3, would this change your answer in part a? Show why.
Hint: The most important variables in a demand function for gasoline are the prices of gasoline and diesel fuel (a substitute over a six year period), average income in the population, the price of automobiles (a complement), and population size. Notice that the question speaks of a six year period, 1974-1979, and that wages rose at 15% each year.
The question belongs to Economics and it discusses about price elasticity of demand for gasoline in France after the Arab oil crisis in 1973-74.
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