Chapter 4 : Elasticity

Question 1

What is an elastic demand?

Answer 1

Demand is elastic when the qt demanded is relatively responsive to changes in price

Question 2

What is an inelastic demand?

Answer 2

Qt demanded is relatively unresponsive to changes in price (Ex. fuel)

Question 3

Impact of an elastic demand on equilibrium price and equilibrium quantity

Answer 3

More elastic demand = big change in equilibrium qt and little change in equilibrium price due to any given shift in the supply curve

Question 4

Equation for price elasticity of demand

Answer 4

N = percentage change in qt demanded / percentage change in price

Question 5

How to calculate the percentage change

Answer 5

for any given interval, % change in qt demanded is delta Qd/the average Qd of that interval

Question 6

Does a linear demand curve have the same price elasticity of demand over the entire curve?

Answer 6

No : moving downward, price elasticity falls continuously due to the increase of the average of Q and the decrease of the average of P

Question 7

What are the extreme cases of price elasticity and what do they mean?

Answer 7

N = infinity : perfectly elastic ->horizontal line

N = 0 : perfectly inelastic -> vertical line

Question 8

What does an N = 1 mean in regards to price elasticity of demand?

Answer 8

It means that the demand is unit elastic.

Question 9

What three factors can impact price elasticity of demand?

Answer 9

1. Availability of substitutes : more substitutes = more elastic demand (people can switch easily)
   Less substitutes = less elasticity (consumers forced to stick to product -eg. fuel)
2. Importance of the good in the consumer’s budget
   Small fraction (eg salt) : inelastic
   Large fraction : elastic
   (Higher price elasticity for more expensive items)
3. Short run and long run
   Elasticity increases with times. Two curves are often useful.

Question 10

Difference in substitute availability for narrowly-defined products vs for broadly-defined products

Answer 10

Narrowly-defined products = more substitutes = more elastic

Broadly-defined products = less substitutes = less elastic

Question 11

What is the total expenditure?

Answer 11

It is the total amount of money spent by buyers for all of their products.

TR = Price x Quantity

Question 12

How does total expenditure change according to price elasticity when price falls?

Answer 12

1. Elastic demand : expenditure ++
2. Inelastic demand : expenditure –
3. Unit elastic : no change

Question 13

How does total expenditure change according to price elasticity when price rises?

Answer 13

1. Elastic demand : expenditure –
2. Inelastic demand : expenditure ++
3. Unit elastic : no change

Question 14

Equation for Ns

Answer 14

Ns = (% change in qt supplied) / (% change in price)

Question 15

Determinants for price elasticity of supply

Answer 15

1. Ease of substitution :
   + easy to switch to production of substitute = elastic supply
   - easy to switch to production of a substitute = inelastic supply
2. Short and long run
   Short : inelastic
   Long : elastic

Question 16

What is an excise tax

Answer 16

= Tax on the sale of a particular product.

Raises the price paid by consumers but reduces the price received by producers.

Question 17

Question of tax incidence

Answer 17

1. If the demand is more elastic than the supply, the suppliers will bear most of the tax burden
2. If the demand is more inelastic than the supply, the consumers will bear most of the tax burden

The least elastic bears the burden

Question 18

Who bears the burden of payroll taxes?

Answer 18

1. Elastic demand of labourers : firms pay most of the tax
2. Inelastic demand of labourers : they pay most of the tax

Question 19

Equation of income elasticity of demand

Answer 19

Ny = % change in qt demanded /% change in income

Question 20

Interpreting Ny

Answer 20

if Ny > 0, the good is a normal good. This means that the quantity demanded varies more than the change in income

if Ny < 0, the good is an inferior good. This means that there is less qt demanded despite the increase in income

Question 21

0 < Ny < 1

Answer 21

Income inelastic : necessity. The more necessary an item is in the consumption pattern of consumers, the lower its income elasticity

Question 22

1 < Ny

Answer 22

Income elastic : luxury

Question 23

Cross price elasticity of demand equation (Nxy)

Answer 23

Nxy = % change in qt demanded of X /% change in price of Y

Question 24

Interpreting Nxy

Answer 24

If Nxy >0 : X and Y are substitutes : a rise in the price of Y leads to an increase in the purchase of X

If Nxy <0 : X and Y are complements : a rise in the price of Y leads to a decrease in the demand of X as well