Chapter 1

Question 1

Elasticity of Demand Equation ED> 1 ED< 1

Answer 1

ED = % change in Quantity Demand /% Change in Price

ED < 1 inelastic: price & revenue move together

ED > 1 elastic: price & revenue move opposite directions

ED = 1 unit Elasticity: when prices changes revenue stays the same

Question 2

Inelastic Demand Determinants

Answer 2

Fewer Substitutes e.g. Appendectomies

Short run (less time) e.g. gas prices today

Entire categories of Products e.g. “Bath Tissues” as a whole

Necessities e.g. medical bills Large Portion of budget e.g. Housing market

Question 3

Elastic Demand Determinants

Answer 3

More substitutes e.g. pens, also depends on preference (is Pepsi a substitute for cola) Long run e.g. gas prices long term (people find other transport) Specific products e.g. “orange crush” has lots of substitutes but orange soda in general does not Luxuries e.g. yachts Small Portion of budget e.g. increase in bread pricing for upper middle class not enough to stop buying bread

Question 4

Elastic vs Inelastic Graphs

Answer 4

Elastic: vertical Inelastic: more horizontal

Question 5

Inelastic Demand Revenue

Answer 5

Revenue = Price x Quantity Inelastic: demand NOT responsive to price PRICE goes UP a LOT QUANTITY goes DOWN a BIT REVENUE goes UP

Question 6

Elastic demand Revenue

Answer 6

Revenue = Price x Quantity Elastic: demand IS responsive to price PRICE goes UP QUANTITY goes DOWN a LOT REVENUE goes DOWN

Question 7

Elasticity application: American farmers vs Computer chipcs

Answer 7

Demand for food is INELASTIC so dropping the price a lot does not increase how much customers want it i.e. DECREASE in PRICE means DECREASE in REVENUE Increasing farm productivity has reduced cost and shifted the supply curve down and reduced prices. Quantity of food demanded has increased less than the price has fallen so farm revenue has decreased. Demand for Computer Chips is ELASTIC so dropping the price does increase how much customers want it i.e. DECREASE in PRICE means INCREASE in REVENUE

Question 8

Inelastic Supply Determinants

Answer 8

Difficult to increase Production at constant Unit Cost e.g. oil production can’t be increased w/o significant increase in cost of production Large share of market for inputs e.g. if housing industry doubled in size, would need much more resources to support (e.g. demand for wood increases dramatically) Global Supply e.g. can’t increase the amount of oil available in whole world Long Run

Question 9

Elastic supply determinants

Answer 9

Easy to increase production at constant unit cost e.g. toothpicks perfectly elastic bc a small increase in price can easily lead to large increase in production Small Share of market for inputs e.g. Local Supply e.g. increased demand for oil in Austin can just ship oil from another US city Short Run