Chapter 6: Elasticity - Price Elasticity of Demand

Question 1

What is price elasticity of demand?

Answer 1

• ratio of the percent change in the quantity demanded to the percent change in the price as we move along the demand curve (dropping the minus sign)

Question 2

How to calculate price elasticity of demand using point elasticity

Answer 2

Question 3

Midpoint method of calculation

Answer 3

• calculate changes in a variable compared with the average of the starting or final values

Question 4

What should we note about demand curve and elasticity?

Answer 4

• straight line demand curve means slope is CONSTANT
• But elasticity changes as we move along the curve
  ie. point elasticity at P=3 is not equal PE at P=6

Question 5

Types of elasticity chart

Answer 5

Question 6

How can demand be perfectly inelastic? (2)

Answer 6

• when the quantity demanded does not respond at all to changes in the price
• when demand is perfectly inelastic, demand curve is a vertical line (numerator is 0)

Question 7

How can demand be perfectly elastic?

Answer 7

• when any price increase will cause the quantity demanded to drop to 0
• when demand is perfectly elastic, the demand curve will be a horizontal line

Question 8

Name some goods that have inelastic demand (4)

Answer 8

• eggs
• beef
• stationery
• Gasoline

Question 9

Name some goods that have elastic demand (4)

Answer 9

• housing
• restaurant meals
• airline travels
• foreign travel

Question 10

When we say a certain good has inelastic/elastic demand, this is with an implicit understanding of the current prices of the goods. What is the correct way of saying this?

Answer 10

at CURRENT prices, the demand for salt is inelastic, demand for diamonds is elastic”

Question 11

is slope a sound basis for judging elasticity? (3)

Answer 11

• no
• we saw that there are elastic portions and inelastic portions of the same curve
• But we do tend to use slope t eyeball the elasticity of demand curves when we are comparing different demand curves

Question 12

Why does it matter whether demand is unit-elastic, inelastic, or elastic?

Answer 12

• it predicts how changes in the price of a good will affect the total revenue earned by producers from the sale of that good

Question 13

What is total revenue?

Answer 13

• total value of sales of a good or service
  Price x quantity sold

Question 14

What happens when a seller raises the price of a good? (3)

Answer 14

two countervailing effects (except rare case of a good with a perfectly elastic/inelastic demand)
- price effect
- quantity effect

Question 15

What is price effect?

Answer 15

• After a price increase, each unit sold sells at a higher price, which tends to raise revenue

Question 16

What is a quantity effect?

Answer 16

• After a price increase, fewer units are sold, which tends to lower revenue

Question 17

Effects of a price increase on total revenue Graph

Answer 17

Question 18

If demand for a good is elastic, an increase in price will do what to revenue? (2)

Answer 18

• reduces total revenue
• in this case, quantity effect is stronger than the price effect

Question 19

If the demand for a good is inelastic, an increase in price will do what to revenue? (2)

Answer 19

• increase total revenue (u do not lose a lot of cust)
• in this case, price effect is stronger than the quantity effect

Question 20

If the demand for a good is unit-elastic (PE = 1), an increase in price will do what to total revenue?

Answer 20

• does not change total revenue
• in this case, the sales effect and price effect exactly offset each other

Question 21

Why does elasticity matter for governments? (3)

Answer 21

• Sales taxes:
• High taxes on cigarettes, alcohol, gas
• “sin” taxes - is the govt trying to stop you from doing bad things, or are they trying to raise as much revenue as possible?
  basically u can raise taxes and see revenue go down