1. Demand Flashcards
A gym conducts a survey of its customers, which shows that a 10% increase in its
fees would lead to a 7% decrease in membership. If the gym wants to increase its
total revenue, it should ______ fees because the demand for gym membership is
______.
a. raise; elastic
b. not raise; elastic
c. raise; inelastic
d. not raise; inelastic
c. raise; inelastic
When the gym increases its fees, and the demand for memberships decreases by a smaller percentage (7% decrease) than the percentage increase in fees (10% increase), it suggests that the demand for gym membership is inelastic. Inelastic demand means that consumers are relatively insensitive to price changes, and the total revenue increases when the price is raised.
An economic study found that the income elasticity of beer was 1.3 and the cross price elasticity between beer and wine was .08. This evidence is consistent with:
a. Beer and wine being complements and beer being a normal good
b. The consumption of beer and wine being non-rivalrous
c. Beer and wine being substitutes and beer being inferior good
d. Beer and wine being substitutes and beer being a normal good
d. Beer and wine being substitutes and beer being a normal good
* Income Elasticity of Beer (1.3):
A positive income elasticity greater than 1 (1.3 in this case) suggests that beer is a normal good. This means that as consumers’ income rises, they are likely to spend a proportionally larger percentage of their income on beer, leading to an increase in the quantity demanded for beer.
- Cross-Price Elasticity between Beer and Wine (0.08):
The positive cross-price elasticity (0.08) suggests that beer and wine are related goods, but the low magnitude (0.08) indicates that they are not close substitutes. When the price of wine increases, the quantity demanded for beer increases, albeit by a small amount. This implies that consumers are not strongly substituting beer for wine or vice versa based on price changes.
Cars and motorcycles are substitutes. A technological breakthrough improves production technology for cars, reducing their marginal cost of production.
Which of the following statements are like to be correct about the new equilibrium compared with the old equilibrium before the technological breakthrough?
(i) Quantity of cars bought in the new equilibrium is larger.
(ii) Quantity of motorcycles bought in the new equilibrium is smaller.
(iii) Prices of both cars and motorcycles will be lower in the new
equilibrium.
a. (i) and (ii)
b. (ii) and (iii)
c. (i) and (iii)
d. (i), (ii), and (iii)
d. (i), (ii), and (iii)
(i) Quantity of cars bought in the new equilibrium is larger:
With a technological breakthrough that reduces the marginal cost of production for cars, it becomes more cost-effective to produce cars. This could lead to an increase in the quantity of cars bought in the new equilibrium as producers may offer more at a lower cost.
(ii) Quantity of motorcycles bought in the new equilibrium is smaller:
Since cars and motorcycles are substitutes, an increase in the quantity of cars bought (due to lower production costs) is likely to result in a decrease in the quantity of motorcycles bought. Consumers may prefer the more cost-effective cars over motorcycles.
(iii) Prices of both cars and motorcycles will be lower in the new equilibrium:
The reduction in the marginal cost of production for cars could lead to a lower equilibrium price for cars. If the decrease in demand for motorcycles (due to increased preference for cars) is significant, it could put downward pressure on motorcycle prices as well.
You decide to buy an aging house and fix it up for resale. You pay $200,000 and spend $100,000 on renovations, at which point you conclude that you can sell the house for only $240,000. As an alternative, you can spend $30,000 more to renovate the kitchen, in which case you expect the house to sell for $290,000.
Which of the following strategies makes the most economic sense?
a. Abandon the house.
b. Sell the house now for $240,000.
c. Complete the kitchen renovation and sell for $290,000
d. Do not sell for any price less than $300,000
c. Complete the kitchen renovation and sell for $290,000
1. Abandon the house:
Initial investment: $200,000 (purchase) + $100,000 (renovations) = $300,000
No resale income.
- Sell the house now for $240,000:
Initial investment: $200,000 (purchase) + $100,000 (renovations) = $300,000
Resale income: $240,000
Net profit/loss: $240,000 - $300,000 = -$60,000 - Complete the kitchen renovation and sell for $290,000:
Additional kitchen renovation cost: $30,000
Total renovation cost: $100,000 (initial renovations) + $30,000 (kitchen renovation) = $130,000
Total investment: $200,000 (purchase) + $130,000 (renovations) = $330,000
Resale income: $290,000
Net profit/loss: $290,000 - $330,000 = -$40,000 - Do not sell for any price less than $300,000:
This option is not explicitly calculated, but it implies that you would hold onto the house until you can sell it for $300,000 or more.
A “classic cappuccino” in a local market is $3.20. Demand for this drink is linear and downward sloping, and at current prices, demand is unitary elastic. All the suppliers in the local market decide to raise the price to $3.80. The most likely outcome is:
a. Quantity demanded will fall, and revenue will rise.
b. Quantity demanded will fall, and revenue will fall.
c. Quantity demanded will remain unchanged, and revenue will rise.
d. Quantity demanded will remain unchanged, and revenue will fall.
b. Quantity demanded will fall, and revenue will fall.
Unitary elastic demand refers to a situation in which the percentage change in quantity demanded is exactly equal to the percentage change in price, resulting in no net change in total revenue. In other words, the price elasticity of demand is equal to -1.
The formula for price elasticity of demand (Ed) is given by:
Ed = % change in quantity demanded / % change in price
For unitary elastic demand, Ed is -1. Mathematically, this can be expressed as:
Ed = -1
The key characteristic of unitary elastic demand is that the percentage change in quantity demanded perfectly offsets the percentage change in price, resulting in total revenue remaining constant. If price increases by a certain percentage, quantity demanded decreases by the same percentage, and vice versa.
Graphically, a unitary elastic demand curve is a straight line with a slope of -1. This means that the demand curve passes through the origin (0,0) on a graph of quantity demanded against price. It is worth noting that unitary elastic demand is a special case and not the norm; most goods and services exhibit either elastic (greater than 1) or inelastic (less than 1) demand.
Which of the following causes a shift in demand?
a. An unexpected drop in supply.
b. An unexpected economic recession.
c. A change in the price level.
d. All of the above.
e. A and B only.
b. An unexpected economic recession.
A shift in demand is caused by factors that affect the willingness or ability of consumers to buy a good or service at all price levels.
a. An unexpected drop in supply:
- This would not directly cause a shift in demand. A drop in supply would typically affect the price (increase it), leading to movement along the demand curve due to changes in the quantity demanded.
b. An unexpected economic recession:
- This is a factor that can cause a shift in demand. During an economic recession, consumers may experience a decrease in income or uncertainty about the future, leading to a decrease in their willingness to buy certain goods or services. This affects demand at all price levels and causes a shift in the demand curve.
c. A change in the price level:
- A change in the price level (movement along the demand curve) does not cause a shift in demand. It is represented by movements along the demand curve, reflecting changes in quantity demanded due to changes in price.
Which of the following is not a variable that influences demand?
a. Price of substitutes.
b. Price of complements.
c. Expectations.
d. Income.
e. None of the above.
e. None of the above.
All of the options mentioned (a, b, c, d) are variables that influence demand. Let’s briefly explain each one:
a. Price of substitutes:
If the price of substitutes (alternative goods or services) increases, consumers may shift their demand towards the relatively cheaper goods, leading to a decrease in demand for the original product.
b. Price of complements:
If the price of complements (goods or services that are consumed together) increases, it may reduce the demand for both products, as consumers may be less willing to buy one without the other.
c. Expectations:
Consumer expectations about future prices, income, or other relevant factors can influence their current demand. For example, if consumers expect prices to rise in the future, they may increase their current demand to avoid higher costs later.
d. Income:
Changes in income can significantly impact consumer demand. For most goods, an increase in income leads to an increase in demand, while a decrease in income may result in a decrease in demand.
Which one of the following factors would increase the demand for oranges?
a. an increase in the price of grapefruit, a substitute product
b. a reduction in the price of bananas, a substitute product
c. development of a line of high-yield orange trees that are also more freeze resistant
d. a decrease in consumer income
a. an increase in the price of grapefruit, a substitute product
Explanation:
a. An increase in the price of grapefruit, a substitute product:
An increase in the price of grapefruit, a substitute for oranges, would likely increase the demand for oranges, as consumers may switch to the relatively cheaper alternative.
b. A reduction in the price of bananas, a substitute product:
A reduction in the price of bananas, another substitute for oranges, would likely decrease the demand for oranges, as consumers may prefer the cheaper option.
c. Development of a line of high-yield orange trees that are also more freeze-resistant:
This factor would increase the supply of oranges rather than directly affecting demand. However, if the increased supply leads to lower prices, it could potentially stimulate more demand for oranges.
d. A decrease in consumer income:
A decrease in consumer income is likely to decrease the demand for most goods, including oranges. When people have less disposable income, they tend to cut back on non-essential purchases.
Clint is about to buy a video game for $50 at a store near campus. His friend Tony tells him: “Hey, I found the same game for $40 online, so you should buy it there instead.” Which of the following is the most accurate?
a. This is a positive statement.
b. This is a normative statement.
c. This is both a positive and normative statement.
c. This is both a positive and normative statement.
Explanation:
a. This is a positive statement:
The statement is conveying a factual claim about the prices of the video game at two different locations: $50 at the store near campus and $40 online. It provides information without expressing any value judgment or opinion.
b. This is a normative statement:
A normative statement involves expressing a value judgment or opinion about what ought to be. For example, Tony said, “You should buy it there,” is an expression of an opinion.
c. This is both a positive and normative statement:
This option is accurate because the statement is primarily providing factual information (positive) and expressing a subjective opinion or value judgment (normative).
If demand is linear, what price maximizes the revenue that sellers can earn in a market?
a. The price at the y-intercept.
b. The price at the x-intercept.
c. The mid-point price between 0 and the y-intercept.
d. The monopoly price.
c. The mid-point price between 0 and the y-intercept.
Explanation:
Understanding Linear Demand:
A linear demand curve is a straight line on a graph, and it can be represented by an equation in the form P=a−bQ, where P is the price, Q is the quantity, and a and b are constants.
Maximizing Revenue:
The total revenue (TR) is given by the product of price (P) and quantity (Q), i.e., TR=P×Q.
For linear demand, as the price increases, quantity demanded decreases, but the increase in price is compensated by the decrease in quantity in a way that may increase total revenue. However, this effect diminishes as the price continues to rise.
At the midpoint between the x-intercept and the y-intercept, the percentage increase in price is balanced by the percentage decrease in quantity, resulting in an optimal point for revenue.
Options Analysis:
a. The price at the y-intercept: This is the highest possible price, but it might not maximize revenue if the decrease in quantity is too steep.
b. The price at the x-intercept: This is where quantity is maximized, but it might not maximize revenue if the price is too low.
c. The mid-point price between 0 and the y-intercept: This is the correct answer as explained above.
d. The monopoly price: The monopoly price is determined by the monopolist’s ability to set prices, and it might or might not coincide with the revenue-maximizing price.
Therefore, the mid-point price between 0 and the y-intercept is the price that maximizes revenue for a linear demand curve.
If the market demand has an elasticity of -2.2, describe what this implies for quantity demanded for a five percent price increase?
The change in quantity demanded is 11%.
Elasticity of demand is a measure of how responsive the quantity demanded of a good is to changes in price. The formula for elasticity (E) is:
E=% Change in Quantity Demanded / % Change in Price
Given that the elasticity (E) is -2.2, this implies that a 1% increase in price would result in a 2.2% decrease in quantity demanded, and vice versa.
Now, if the price increases by 5%, we can use the elasticity to estimate the percentage change in quantity demanded.
E=% Change in Quantity Demanded / % Change in PriceE
Substitute in the known values:
−2.2 = % Change in Quantity Demanded / 5%
Solve for the percentage change in quantity demanded:
Change in Quantity Demanded = −2.2 × 5% = −11%
Therefore, a 5% increase in price would lead to an estimated 11% decrease in quantity demanded. This negative relationship indicates that the good is elastic; consumers are relatively responsive to changes in price.
Cross-price elasticity of demand is used to relate what two variables?
The percentage change in quantity demanded of good x and the percentage change in the price of good* y*.
Cross-price elasticity of demand measures how the quantity demanded of one good responds to a change in the price of another good. It quantifies the sensitivity of the quantity demanded of one good to a change in the price of another good. The formula for cross-price elasticity (Exy) is:
Exy = % Change in Quantity Demanded of Good X / % Change in Price of Good Y
Here:
Exy is the cross-price elasticity of demand between goods X and Y.
The numerator represents the percentage change in the quantity demanded of good X.
The denominator represents the percentage change in the price of good Y.
The sign of the cross-price elasticity indicates the nature of the relationship between the two goods:
If Exy is positive, the goods are substitutes (an increase in the price of Y leads to an increase in the quantity demanded of X, and vice versa).
If Exy is negative, the goods are complements (an increase in the price of Y leads to a decrease in the quantity demanded of X, and vice versa).
If Exy is zero, the goods are unrelated.
In summary, cross-price elasticity of demand relates the percentage change in the quantity demanded of one good to the percentage change in the price of another good, providing insights into the relationship between the two goods in terms of substitution or complementarity.
If there are two or more firms in a market, will each firm’s elasticity be less than, greater than, or equal to the market demand elasticity in absolute value? Why?
Greater than because there are more substitutes for a specific firm’s product than for the product as a whole.
The elasticity of each firm in a market will typically be less than the market demand elasticity in absolute value. This is due to the fact that individual firms usually face a more elastic demand curve compared to the overall market demand curve. Let’s break down the reasons:
Perfectly Competitive Market:
In a perfectly competitive market, each firm is a price taker. This means that individual firms cannot influence the market price; they can only sell their output at the prevailing market price.
Horizontal Demand Curve:
The demand curve facing a perfectly competitive firm is perfectly elastic, which is a horizontal line at the market price. This is because the firm can sell any quantity it desires at the market price, but it cannot sell any quantity at a higher price.
Elasticity and Perfect Competition:
The elasticity of demand for a perfectly competitive firm is infinite (perfectly elastic). This is because a small change in price would result in a complete loss of customers or a gain of all customers in the market.
Market Demand Elasticity:
The market demand elasticity, on the other hand, is typically less elastic than the individual firm’s demand elasticity. This is because individual firms in a competitive market can sell any quantity at the market price, while the market as a whole has a more inelastic demand curve.
In summary, each firm’s elasticity will be greater (in absolute value) than the market demand elasticity because the individual firm faces a perfectly elastic demand curve (infinite elasticity) due to the competitive nature of the market. The market demand curve is relatively more inelastic compared to the demand curve facing an individual firm.
