Chapter 4

Question 1

What is ELASTICITY?

Answer 1

Elasticity - measure of how much consumers and producers will respond to a change in market conditions

Price elasticity of demand
Price elasticity of supply
Cross-price elasticity of demand
Income elasticity of demand

Question 2

Price elasticity of demand

Answer 2

Change in the quantity demanded of a good or service when price changes

Ep = Percentage change in Quantity Demand/Percentage change in price

Ep = %Q/%P

Question 3

Price elasticity of demandPt.2

Answer 3

a. Elastic Demand %Q > %P, Ep > 1; Quantity demanded is relatively responsive to price.

b. Unit Elastic %Q = %P, Ep = 1;

c. Inelastic Demand %Q < %P, Ep < 1; Quantity demanded is relatively less responsive to price.

d. Perfectly Inelastic Demand No matter what the price, quantity demanded does not change.
EP = 0 (Perfect inelasticity, or zero elasticity), people need insulin no matter the price as it is a necessity over anything

e. Perfectly elastic Demand

The slightest increase in price leads
to zero quantity demanded.
EP = infinity (Perfect elasticity or infinite elasticity

Question 4

Determinants of Price Elasticity of Demand

Answer 4

1. Availability of substitutes: the more substitutes there are, the more elastic is demand
2. Time to adapt to price changes:

The longer any price change persists, the greater is the price elasticity of demand.
Price elasticity is greater in the long run than in the short run

3. Relative need vs. cost: The smaller the share of the consumer’s total budget spent on a good, the smaller is the price elasticity of demand.
   Demand for a Package of Salt is more inelastic than Demand for a vacation to Mexico?
4. Scope of the market
   The price elasticity of demand depends on the definition of the market. (Specific versus broader definition)
   Example: The price elasticity of demand for banana might be higher than price elasticity of demand for fruits due to substitution.

Question 5

Price elasticity of demand and Total Revenue

Answer 5

Total revenue: the quantity sold multiplied by the price paid for each unit

TR = Price x Quantity

Price increases affect total revenue in two ways:

1. Quantity effect - decrease in revenue from selling fewer units of the good
2. Price effect - increase in revenue from receiving a higher price for each unit sold

Question 6

Price elasticity of demand Quantity vs. Price Effect

Answer 6

Quantity effect outweighs the price effect, a price increase will cause a drop in revenue

Price effect outweighs the quantity effect, a price increase will raise total revenue

Question 7

Price elasticity of supply

Answer 7

Size of the change in quantity supplied when price changes; producers’ responsiveness to price change

Es = percentage change in quantity supplied / percentage change in price

Elastic - value >1
Inelastic - value <1
Unit-elastic - value =1

Question 8

Determinants of Price elasticity of Supply

Answer 8

1. Availability of inputs
   For Construction
   For Restaurant
2. Flexibility of the production process
   Farmers assign hectares to more profitable crops, e.g. if price of corn is high they may plant more corn if it is less they may plant different
3. Time
   Supply is more elastic over long period of time than short period of time. (Can make more adjustment in the long-run.)

Question 9

Cross-price elasticity of demand

Answer 9

Describes how quantity demand of one good changes when the price of adifferentgood changes

If two goods are substitutes, their cross-price elasticity of demand should be positive

If two goods are complements (consumed together), cross-price elasticity will be negative

Question 10

Income elasticity of demand

Answer 10

Describes how much quantity demanded changes in response to a change in consumers’ incomes.

Income elasticity of demand is negative for inferior goods; quantity demand decreases as incomes rise.

Income elasticity of demand is positive for normal, luxury and necessity goods; quantity demand increases as incomes rise.