www.hoddereducation.co.

uk/economicreview

Volume 35, Number 1, September 2017

Answers

Quantitative skills: Elasticity

Peter Smith

This resource provides answers to the questions set in the column on elasticity,
on pp. 5–7 of the September 2017 issue of ECONOMIC REVIEW.

Question 1
A firm is selling 500 units of a good at a price of £20. Having increased the price to £25, the
quantity demanded falls to 425 units. Calculate the price elasticity of demand.

The percentage change in price is 100*(25 - 20)/20 = +25, and the percentage change in quantity
demanded is 100*(425 - 500) / 500 = -15, so the elasticity is -0.6. Demand is price-inelastic.

Question 2
A firm reduces price from £50 to £45, and finds that the quantity demanded increases from 60
to 69. Calculate the price elasticity of demand.

The percentage change in price is 100*(45 - 50)/50 = -10, and the percentage change in quantity
demanded is 100*(69 - 60) / 60 = -15, so the elasticity is -1.5. Demand is price-elastic.

Question 3
The average income of a firm’s customers increases from £500 per week to £600, and the
quantity demanded of the firm’s product goes from 5,000 to 6,000 units. Calculate the income
elasticity of demand and state whether the good is a normal or inferior good.

The percentage change in income is 100*(600 - 500) / 500 = +20, and the percentage change in
quantity demanded is 100*(6,000 – 5,000) / 5,000 = +40, so the income elasticity of demand is
40 / 20 = +2. As this is positive the good is a normal good.

Question 4
A firm selling 400 units of a good per week observes that a rival firm raises its price from £10 to
£11. The result is that the firm experiences a rise in sales to 420 per week. Calculate the cross-
price elasticity of demand, and comment on whether the goods are substitutes or
complements.

The percentage change in quantity is 100*(420 - 400) / 400 = +5, and the percentage change in the
rivals’ price is 100*(11 - 10) / 10 = +10, so the cross-price elasticity of demand is +0.5. This suggests
that the two goods are substitutes.

Hodder & Stoughton © 2017 www.hoddereducation.co.uk/economicreview

 www.hoddereducation.co.uk/economicreview

Question 5
Discuss ways in which a firm could benefit from being aware of the various elasticity
measures.

Elasticity can be important to a firm that is contemplating changes in market strategy. For example,
should a firm change the price of its product? If the firm knows that the demand for its product is highly
elastic, then it will be aware that an increase in price will result in a relatively large fall in quantity
demanded, and thus a fall in sales revenue. On the other hand, reducing the price when demand is
inelastic may equally cause a fall in revenue.

Whether a firm has firm information about the elasticity of demand is a different question. It may be
able to come to a view that it is familiar with its market – for example if it knows that there are few
substitutes for its good, then demand may be relatively inelastic. The firm’s view may also have to take
into account the possible actions of rival firms in response to a change in price.

The cross-price elasticity may be significant if a firm can see (or anticipate) changes in price made by
other firms.

The income elasticity may be important if there is a change in the economic circumstances of its
customers, or if the economy generally is heading into (or out of) recession.

This resource is part of ECONOMIC REVIEW, a magazine written for A-level students by
subject experts. To subscribe to the full magazine go
to www.hoddereducation.co.uk/economicreview

Hodder & Stoughton © 2017 www.hoddereducation.co.uk/economicreview