BASIC ECONOMICS
TUTORIAL 3
Elasticity and Its Application
This week’s tutorial looks at Elasticity and Its Application. Please prepare these problems
prior to attending tutorials.
Quick Quiz (Text book)
- Chapter 5
Problems and Applications (Text book)
- Chapter 5 (1, 2, 3,7, 8)
True/False
Multiple choice
READING GUIDE
Review Chapter 5 of Principles of Economics (10th edition) – N. Gregory Mankiw as
preparation for this tutorial. You should also look overcarefully your lectures notes for
Week 3.
CHAPTER 5 - SUMMARY
Price Elasticity of Demand
1
- The price elasticity of demand measures how much the quantity demanded (Qd)
responds to a change in price (P)
- Price elasticity can be calculated by multiplying the slope of demand (∆Q/∆P)
times the ratio of price to quantity (P/Q)
Note: Along a D curve, P and Q
move in opposite directions,
which would make price elasticity
negative. We will drop the minus
sign and report all price elasticities
as positive numbers.
- Price Elasticity of Demand Using the Midpoint Formula: The midpoint
formula is preferable when calculating the price elasticity of demand because it
gives the same answer regardless of the direction of the change
Example: Use the following information to calculate the price elasticity of demand
for hotel rooms:
if P = $70, Qd = 5000
if P = $90, Qd = 3000
Answers:
Use midpoint method to calculate % change in Qd:
% change in P:
The price elasticity of demand equals:
- The price elasticity of demand determines whether the demand curve is steep or flat
1. Perfectly inelastic demand
D curve: vertical
2. Inelastic demand
D curve: relatively steep
3. Unit elastic demand
D curve: intermediate slope
4. Elastic demand
D curve: relatively flat
5. Perfectly elastic demand
D curve: horizontal
- Elasticity of a Linear Demand
+ At points with a low price and high quantity, the
demand curve is inelastic
+ At points with a high price and low quantity, the
demand curve is elastic
- Price Elasticity and Total Revenue
TR reaches a maximum at the rate of
output where D is unit elastic
- Factors Affecting Price Elasticity of Demand
+ Availability of substitutes: The better & more numerous the substitutes for a good,
the more elastic is demand
+ Percentage of consumer’s budget: The greater the percentage of the consumer’s
budget spent on the good, the more elastic is demand
+ Time period of adjustment: The longer the time period consumers have to adjust to
price changes, the more elastic is demand
+ Necessities versus Luxuries: Luxuries have a more elastic demand
+ Definition of the market: The more finely defined the market the more elastic the
demand. The more aggregate the definition of the market the more inelastic the
demand
Income Elasticity of Demand
2
- The income elasticity of demand measures how the quantity demanded changes
as consumer income changes
- Midpoint Method
Normal goods Inferior goods
EDI > 0 EDI < 0
I,Q I,Q
I,Q I,Q
Cross – price Elasticity of Demand
3
- The cross-price elasticity of demand measures how the quantity demanded of one
good responds to a change in the price of another good
- Midpoint Method
If the products are... Then the cross-price elasticity of demand will be...
substitutes positive
complements negative
unrelated zero
Price Elasticity of Supply
4
- The price elasticity of supply measures how much the quantity supplied (Q S) responds
to a change in price (P)
- Midpoint Method
1. Perfectly inelastic supply
S curve: vertical
2. Inelastic supply
S curve: relatively steep
3. Unit elastic supply
S curve: intermediate slope
4. Elastic supply
S curve: relatively flat
5. Perfectly elastic supply
S curve: horizontal
- How the Price Elasticity of Supply Can Vary
The elasticity of supply may be very
high at low levels of quantity supplied
and very low at high levels of quantity
supplied
- The Determinants of Supply Elasticity
+ The more easily sellers can change the quantity they produce, the greater the price
elasticity of supply.
+ For many goods, price elasticity of supply is greater in the long run than in the short
run.
TRUE/FALSE
TRUE FALSE
1. Necessities tend to have inelastic demands, whereas luxuries have
elastic demands
2. The demand for soap is more elastic than the demand for Dove soap
3. The demand for gasoline will respond more to a change in price
over a period of five weeks than over a period of five years
4. Suppose that when the price rises by 20% for a particular good, the
quantity demanded of that good falls by 10%. The price elasticity
of demand for this good is equal to 2.0
5. If a firm is facing elastic demand, then the firm should decrease
price to increase revenue
6. Normal goods have negative income elasticities of demand, while
inferior goods have positive income elasticities of demand
7. Cross-price elasticity is used to determine whether goods are
inferior or normal goods
8. Supply tends to be more elastic in the short run and more inelastic
in the long run
9. A government program that reduces land under cultivation hurts
farmers but helps consumers
10. OPEC failed to maintain a high price of oil in the long run, partly
because both the supply of oil and the demand for oil are more
elastic in the long run than in the short run
SHORT QUESTIONS
1. Consider the following pairs of goods. For which of the two goods would you
expect the demand to be more price elastic? Why?
a) water or diamonds
b) insulin or nasal decongestant spray
c) food in general or breakfast cereal
d) gasoline over the course of a week or gasoline over the course of a year
e) personal computers or IBM personal computers.
2. Use the graph shown to answer the following questions. Put the correct letter(s) in
the blank.
Price
A
Demand
C Quantity
a) The elastic section of the graph is represented by section from __
b) The inelastic section of the graph is represented by section from __
c) The unit elastic section of the graph is represented by section __
d) The portion of the graph in which a decrease in price would cause total revenue
to fall would be from __
e) The portion of the graph in which a decrease in price would cause total revenue
to rise would be from __
f) The portion of the graph in which a decrease in price would not cause a change
in total revenue would be __
g) The section of the graph in which total revenue would be at a maximum would be __
h) The section of the graph in which elasticity is greater than 1 is __
i) The section of the graph in which elasticity is equal to 1 is _
j) The section of the graph in which elasticity is less than 1 is __
MULTIPLE CHOICE
1. Which of the following is not a determinant of the price elasticity of demand for a good?
Ⓐ the time horizon Ⓒ the definition of the market for the
good
Ⓑ the steepness or flatness of the supply Ⓓ the availability of substitutes for the
curve for the good good
2. For which of the following goods would demand be most elastic?
Ⓐ clothing Ⓒ Tommy Hilfiger jeans
Ⓑ blue jeans Ⓓ All three would have the same
elasticity of demand since they are
all related.
3. Whether a good is a luxury or necessity depends on
Ⓐ the price of the good Ⓒ the intrinsic properties of the good
Ⓑ the preferences of the buyer Ⓓ how scarce the good is.
4. Suppose there is a 6 percent increase in the price of good X and a resulting 6
percent decrease in the quantity of X demanded. Price elasticity of demand for X is
Ⓐ 0 Ⓒ6
Ⓑ1 Ⓓ 36
5. If the price elasticity of demand for a good is 4.0, then a 10 percent increase in price
results in a
Ⓐ 0.4 percent decrease in the quantity Ⓒ 4 percent decrease in the quantity
demanded demanded
Ⓑ 2.5 percent decrease in the quantity Ⓓ 40 percent decrease in the quantity
demanded demanded
6. For a particular good, a 2 percent increase in price causes a 12 percent decrease in
quantity demanded. Which of the following statements is most likely applicable to
this good?
Ⓐ There are no close substitutes for this Ⓒ The market for the good is broadly
good defined
Ⓑ The good is a luxury Ⓓ The relevant time horizon is short
7. When we move upward and to the left along a linear, downward-sloping demand
curve, price elasticity of demand
Ⓐ first becomes smaller, then larger Ⓒ always becomes smaller
Ⓑ always becomes larger Ⓓ first becomes larger, then smaller
Figure 3-1
Price
A
B
C
D D
C
B
A Quantity
8. Refer to Figure 3-1. The demand curve representing the demand for a luxury good
with several close substitutes is
Ⓐ A ⒸC
ⒷB ⒹD
9. Refer to Figure 3-1. Ann says he would buy one cup of coffee per day regardless
of the price. If this is true, then Atog's demand for coffee is represented by
demand curve
ⒶA ⒸC
ⒷB ⒹD
10. If demand is price inelastic, then
Ⓐ buyers do not respond much to a change Ⓒ buyers do not alter their quantities
in price demanded much in response to
advertising, fads, or general changes
in tastes
Ⓑ buyers respond substantially to a change Ⓓ the demand curve is very flat
in price, but the response is very slow
11. Suppose demand is perfectly elastic, and the supply of the good in question
decreases. As a result,
Ⓐ the equilibrium quantity decreases, and Ⓒ the equilibrium quantity and the
the equilibrium price is unchanged equilibrium price both are unchanged
Ⓑ the equilibrium price increases, and the Ⓓ buyers’ total expenditure on the
equilibrium quantity is unchanged good is unchanged
12. A perfectly inelastic demand implies that buyers
Ⓐ decrease their purchases when the price Ⓒ increase their purchases only slightly
rises when the price falls
Ⓑ purchase the same amount as before Ⓓ respond substantially to an increase
when the price rises or falls in price
13. When the price of good A is $50, the quantity demanded of good A is 500 units.
When the price of good A rises to $70, the quantity demanded of good A falls to
400 units. Using the midpoint method,
Ⓐ the price elasticity of demand for good Ⓒ the price elasticity of demand for
A is 1.50, and an increase in price will good A is 0.67, and an increase in
result in an increase in total revenue for price will result in an increase in
good A total revenue for good A
Ⓑ the price elasticity of demand for good Ⓓ the price elasticity of demand for
A is 1.50, and an increase in price will good A is 0.67, and an increase in
result in a decrease in total revenue for price will result in a decrease in total
good A revenue for good A
14. Barb's Bakery earned $200 in total revenue last month when it sold 100 loaves of
bread. This month it earned $300 in total revenue when it sold 60 loaves of bread.
The price elasticity of demand for Barb's bread is
Ⓐ 0.27 Ⓒ 1.25
Ⓑ 0.58 Ⓓ 1.71
15. If a change in the price of a good results in no change in total revenue, then
Ⓐ the demand for the good must be elastic Ⓒ the demand for the good must be
unit elastic
Ⓑ the demand for the good must be Ⓓ buyers must not respond very much
inelastic to a change in price
16. In which of the following situations will total revenue increase?
Ⓐ Price elasticity of demand is 1.2, and Ⓒ Price elasticity of demand is 3.0, and
the price of the good decreases the price of the good decreases
Ⓑ Price elasticity of demand is 0.5, and Ⓓ All of the above are correct
the price of the good increases
17. Holding all other forces constant, if increasing the price of a good leads to an
increase in total revenue, then the demand for the good must be
Ⓐ unit elastic Ⓒ elastic
Ⓑ inelastic Ⓓ None of the above is correct, since a
price increase always leads to an
increase in total revenue
18. On a downward-sloping linear demand curve, total revenue reaches its maximum
value at the
Ⓐ midpoint of the demand curve Ⓒ upper end of the demand curve
Ⓑ lower end of the demand curve Ⓓ It is impossible to tell without knowing
prices and quantities demanded
19. Last year, Sheila bought 6 pairs of shoes when her income was $40,000. This year,
her income is $52,000 and she purchased 7 pairs of shoes. Holding other factors
constant and using the midpoint method, it follows that Sheila’s income elasticity
of demand is about
Ⓐ 0.59, and Sheila regards shoes as an Ⓒ 1.7, and Sheila regards shoes as an
inferior good inferior good
Ⓑ 0.59, and Sheila regards shoes as a Ⓓ 1.7, and Sheila regards shoes as a
normal good normal good
20. Necessities such as food and clothing tend to have
Ⓐ high price elasticities of demand and Ⓒ low price elasticities of demand and
high income elasticities of demand high income elasticities of demand
Ⓑ high price elasticities of demand and Ⓓ low price elasticities of demand and
low income elasticities of demand low income elasticities of demand
21. To determine whether a good is considered normal or inferior, one could examine
the value of the
Ⓐ income elasticity of demand for that Ⓒ price elasticity of supply for that
good good
Ⓑ price elasticity of demand for that good Ⓓ cross-price elasticity of demand for
that good
22. May's income elasticity of demand for football tickets is 1.50. All else equal, this
means that if her income increases by 20 percent, she will buy
Ⓐ 150 percent more football tickets Ⓒ 30 percent more football tickets
Ⓑ 50 percent more football tickets Ⓓ 20 percent more football tickets
23. Suppose that when the price of good X falls from $10 to $8, the quantity
demanded of good Y rises from 20 units to 25 units. Using the midpoint method,
Ⓐ the cross-price elasticity of demand is - Ⓒ the cross-price elasticity of demand
1.0, and X and Y are complements is 1.0, and X and Y are complements
Ⓑ the cross-price elasticity of demand is - Ⓓ the cross-price elasticity of demand
1.0, and X and Y are substitutes is 1.0, and X and Y are substitutes
24. Last month, sellers of good Y took in $100 in total revenue on sales of 50 units of
good Y. This month sellers of good Y raised their price and took in $120 in total
revenue on sales of 40 units of good Y. At the same time, the price of good X
stayed the same, but sales of good X increased from 20 units to 40 units. We can
conclude that goods X and Y are
Ⓐ substitutes, and have a cross-price Ⓒ substitutes, and have a cross-price
elasticity of 0.60 elasticity of 1.67
Ⓑ complements, and have a cross-price Ⓓ complements, and have a cross-price
elasticity of 0.60 elasticity of 1.67
25. The cross-price elasticity of demand can tell us whether goods are
Ⓐ normal or inferior Ⓒ luxuries or necessities
Ⓑ elastic or inelastic Ⓓ complements or substitutes
26. Frequently, in the short run, the quantity supplied of a good is
Ⓐ impossible, or nearly impossible, to Ⓒ determined by the quantity
measure demanded of the good
Ⓑ not very responsive to price changes Ⓓ determined by psychological forces
and other non-economic forces
27. When a supply curve is relatively flat
Ⓐ sellers are not at all responsive to a Ⓒ the supply is relatively elastic
change in price
Ⓑ the equilibrium price changes Ⓓ the supply is relatively inelastic
substantially when the demand for the
good changes
28. If a 25% change in price results in a 40% change in quantity supplied, then the
price elasticity of supply is
Ⓐ 0.63, and supply is elastic Ⓒ 1.60, and supply is elastic
Ⓑ 0.63, and supply is inelastic Ⓓ 1.60, and supply is inelastic
29. If the price elasticity of supply is 1.5, and a price increase led to a 1.8% increase in
quantity supplied, then the price increase amounted to
Ⓐ 0.67% Ⓒ 1.20%
Ⓑ 0.83% Ⓓ 2.70%
30. Suppose the price elasticity of supply for how-to books is 0.3 in the short run and
1.2 in the long run. If an increase in the demand for how-to books causes the
price of how-to books to increase by 20%, then the quantity supplied of how-to
books will increase by
Ⓐ 0.67% in the short run and 0.17% in the Ⓒ 6% in the short run and 24% in the
long run long run
Ⓑ 3% in the short run and 1.2% in the Ⓓ 66.7% in the short run and 16.7% in
long run the long run
Figure 3-2
The following figure shows the supply curve for a particular good
Price
430 Supply
220
100
40
16
2 5 9 14 20 Quantity
31. Refer to Figure 3-2. Over which range is the supply curve in this figure the most
elastic?
Ⓐ Between $16 and $40 Ⓒ Between $100 and $220
Ⓑ Between $40 and $100 Ⓓ Between $220 and $430
32. Refer to Figure 3-2. Over which range is the supply curve in this figure the least
elastic?
Ⓐ Between $16 and $40 Ⓒ Between $100 and $220
Ⓑ Between $40 and $100 Ⓓ Between $220 and $430
33. Refer to Figure 3-2. Using the midpoint method, what is the price elasticity of
supply between $16 and $40?
Ⓐ 0.125 Ⓒ 1.0
Ⓑ 0.86 Ⓓ 2.5
34. Suppose that an increase in the price of carrots from $1.30 to $1.80 per pound
increases the quantity of carrots that carrot farmers produce from 1.2 million
pounds to 1.6 million pounds. Using the midpoint method, what is the
approximate value of the price elasticity of supply?
Ⓐ 0.67 Ⓒ 1.00
Ⓑ 0.89 Ⓓ 1.13
35. An advance in farm technology that results in an increased market supply is
Ⓐ good for farmers because it raises prices Ⓒ good for farmers because it raises
for their products but bad for consumers prices for their products and also
because it raises prices consumers pay good for consumers because more
for food output is available for consumption
Ⓑ bad for farmers because total revenue Ⓓ bad for farmers because total
will fall but good for consumers revenue will fall and bad for
because prices for food will fall consumers because farmers will
raise the price of food to increase
their total revenue
36. If corn farmers know that the demand for corn is inelastic, and they want to
increase their total revenue, they should all
Ⓐ plant more corn so that they would be Ⓒ reduce the number of acres they
able to sell more each year plant in corn
Ⓑ increase spending on fertilizer in an Ⓓ contribute to a fund that promotes
attempt to produce more corn on the technological advances in corn
acres they farm production
37. If the price elasticity of supply for a good is equal to infinity, then
Ⓐ the supply curve is vertical Ⓒ the supply curve also has a slope
equal to infinity
Ⓑ the supply curve is horizontal Ⓓ the quantity supplied is constant
regardless of the price
