Chapter 5 :(Elasticity and Its Application)

Section A
1. Which of the following is not a determinant of the price elasticity of demand for a
good?
a. The time horizon.
b. The steepness or flatness of the supply curve for the good.
c. The definition of the market for the good.
d. The availability of substitutes for the good.

2. If the price elasticity of demand for a good is 4.0, then a 10 percent increase in
price results in a
a. 0.4 percent decrease in the quantity demanded. PED = -4
b. 2.5 percent decrease in the quantity demanded.
c. 4 percent decrease in the quantity demanded.
d. 40 percent decrease in the quantity demanded.

PED = -4 = % change Q/% change P = % change Q / +10%

% change in Q = -4 x 10% = -40%

3. Consider airfares on flights between Kuala Lumpur and Singapore. When the
airfare is $250, the quantity demanded of tickets are 2,000 per week. When the
airfare is $280, the quantity demanded of tickets are 1,700 per week. Using the
midpoint method,

Po = $250 P1 = $280
Qo= 2000 Q1 = 1700

PED = (-300/30) x ( 265/1850) = (-)1.43(elastic)

a. the price elasticity of demand is about 1.43 and an increase in the airfare
will cause airlines' total revenue to decrease.
b. the price elasticity of demand is about 1.43 and an increase in the airfare
will cause airlines' total revenue to increase.
c. the price elasticity of demand is about 0.70 and an increase in the airfare
will cause airlines' total revenue to decrease.
d. the price elasticity of demand is about 0.70 and an increase in the airfare
will cause airlines' total revenue to increase.

4. The case of perfectly elastic demand is illustrated by a demand curve that is

a. vertical.
b. horizontal.
c. downward-sloping but relatively steep.
d. downward-sloping but relatively flat.

5. Suppose demand is perfectly inelastic and the supply of the good in question
decreases. As a result,
a. the equilibrium quantity decreases and the equilibrium price is unchanged.
b. the equilibrium price increases and the equilibrium quantity is unchanged.
 c. the equilibrium quantity and the equilibrium price both are unchanged.
d. buyers’ total expenditure on the good is unchanged.

6. On a downward-sloping linear demand curve, total revenue reaches its maximum

value at the
a. lower end of the demand curve.
b. upper end of the demand curve.
c. midpoint of the demand curve.
d. It is impossible to tell without knowing prices and quantities demanded.

7. If a 6 percent increase in income results in a 10 percent increase in the quantity

demanded of pizza, then the income elasticity of demand for pizza is
a. negative and therefore pizza is an normal good.
b. negative and therefore pizza is a inferior good.
c. positive and therefore pizza is an inferior good.
d. positive and therefore pizza is a normal good.

8. 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

Py increases from $2 to $3. XED = (20/1) x (2.5/30) = 1.67

DX increase from 20 to 40

a. substitutes, and have a cross-price elasticity of 0.60.

b. complements, and have a cross-price elasticity of 0.60.
c. substitutes, and have a cross-price elasticity of 1.67.
d. complements, and have a cross-price elasticity of 1.67.

9. A key determinant of the price elasticity of supply is

a. the ability of sellers to change the price of the good they produce.
b. the ability of sellers to change the amount of the good they produce.
c. how responsive buyers are to changes in sellers' prices.
d. the slope of the demand curve.

10. Other things equal, the demand for a good tends to be more inelastic, the
a. fewer the available substitutes.
b. longer the time period considered.
c. more the good is considered a luxury good.
d. more narrowly defined is the market for the good.

11. Suppose demand is perfectly elastic and the supply of the good in question
decreases. As a result,
 a. the equilibrium quantity decreases and the equilibrium price is unchanged.
b. the equilibrium price increases and the equilibrium quantity is unchanged.
c. the equilibrium quantity and the equilibrium price both are unchanged.
d. buyers’ total expenditure on the good is unchanged.

12. An increase in price causes an increase in total revenue when

a. demand is elastic.
b. demand is inelastic.
c. demand is unit elastic.
d. All of the above are possible

13. A person who takes a prescription drug to control high cholesterol most likely has
a demand for that drug that is
a. inelastic.
b. elastic.
c. unit elastic.
d. highly responsive to changes in income.

14. Which of the following is not a determinant of the price elasticity of demand for a
good?
a. the steepness or flatness of the supply curve for the good
b. the time horizon
c. the definition of the market for the good
d. the availability of substitutes for the good

15. How does total revenue change as one moves downward and to the right along a
linear demand curve?
a. It always increases
b. It always decreases.
c. It first increases, then decreases.
d. It is unaffected by a movement along the demand curve.
 16.

The figure above illustrates a linear demand curve. In the price range from $8 to $6,
demand is ____ and in the price range $4 to $2, demand is ____.
a. elastic; elastic
b. elastic; inelastic
c. inelastic; elastic
d. inelastic; inelastic

Section B
Question 1
What are the main influences of the elasticity of supply that make the supply of some goods elastic
and the supply of other goods inelastic?

 Excess capacity = unused capacity

 Storage
 Type of resources – common or unique
 Time

Question 2
 The above figure shows the demand curve for movie rentals from Blockbuster.

a) Determine the price elasticity of demand if Blockbuster raised its price from $2.50 to $3.00.

Po = $2.50 P1= $3.00

Qo = 5 Q1 = 4

PED = (-1/$0.50) x ($2.75/4.5) = (-) 1.2 (elastic)

b) At which of the following prices is the demand unit elastic?

P=$2.50

c) At which of the following prices does Blockbuster have the maximum total revenue and how
much is the maximum total revenue?
P=$2.50 Q = 5 units TR = $2.50 x 5 = $12.50

d) What will happen if Blockbuster lowered its price from $4.00 to $3.50?
PED> 1 , lower P ----TR will increase.

Section C
Question 1
a) The price elasticity of demand for a monopolist’s product is –0.7. Advise the firm on its
pricing strategy.

PED = - 0.7 (Inelastic)

Advise : increase P , % increase P > % fall Q , TR will increase

b) A firm sells two products: A and B. Product A has an income elasticity of demand of +1.3 and
product B has an income elasticity of –1.4. Advise this firm on how it might plan its
production in the coming year if real consumer incomes are set to rise by 12%.

YED(A) = 1.3 (A= normal or luxury good) Y increase the QA will increase.
YED(B) = -1.4 (B = inferior or giffen good) when Y increase QB will fall.

YED(A) = % change QA/% change Y

1.3 = % change QA/12%
% change QA = 1.3 x 12% = 15.6%
YED(B) = % change QB/% change Y
-1.4 = % change QA/12%
% change QB = -1.4 x 12% = - 16.8%

c) A firm sells two products: C and D. C has a cross elasticity of demand with another firm’s
product (product E) of +0.8 whilst D has a cross elasticity of demand with another firm’s
product (product F) of –1.9. Advise the firm on how its sales would be affected by a fall in
the price of the other firms’ products of 25%.

XED(C,E) = 0.8 (C and E are substitutes)

XED(D,F) = -1.9 (D and F are complements)

XED(C,E) = % change QC/% change PE

0.8 = % change QA/-25%
% change QC = 0.8 x (-25% )= - 20%

XED(D,F) = % change QD/% change PF

-1.9 = % change QA/-25%
% change QC = -1.9 x (-25% )= 47.5%

Question 2
a) Distinguish between price elasticity of demand, income elasticity of demand and cross
elasticity of demand.
- The price elasticity of demand measures how much the quantity demanded responds to
a change in price
- income elasticity of demand is a measure of how much the quantity demanded of a
good responds to a change in consumers’ income, computed as the percentage change
in quantity demanded divided by the percentage change in income
- cross elasticity of demand a measure of how much the quantity demanded of one good
responds to a change in the price of another good, computed as the percentage change
in quantity demanded of the first good divided by the percentage change in price of the
second good

b) Explain the relationship between price elasticity of demand and total revenue or total
expenditure.

When demand is elastic, a fall in the price of a commodity results in increase in total
expenditure on it. On the other hand, when price increases, total expenditure decreases. It
means, in case of highly elastic demand, price and total expenditure move in the opposite
directions
2. Which causes a shortage of a good—a price ceiling or a price floor? Justify your answer with a graph.
Because buyers of any good always want a lower price while sellers want a higher price, the interests of the
two groups conflict.

4. Explain why economists usually oppose controls on prices.

Economists usually oppose controls on prices because prices have the crucial job of coordinating economic
activity by balancing demand and supply.
5. Suppose the government removes a tax on buyers of a good and levies a tax of the same size on sellers of
the good. How does this change in tax policy affect the price that buyers pay sellers for this good, the amount
buyers are out of pocket (including any tax payments they make), the amount sellers receive (net of any tax
payments they make), and the quantity of the good sold?