Tutorial 4 ELASTICITY

Chapter 4
Review Questions
1. The price elasticity of demand depends on the income of consumers because
relative changes, either in the price of the good, or changes in the income,
affect the purchasing power of consumers. Furthermore, the share of the
income allocated to a specific good, also affects the price elasticity of
demand of that product. For example, a drastic increase in the price of salt, a
good that accounts for very little share of most peoples income, would not
change the quantity demanded by very much, whereas a drastic increase in
airfares, which account for a larger share of consumer income, would cause
many people to avoid flying during that period of increased fare. This shift in
price, causing varying degrees of shifts in quantity changes depending of the
type of good in question.
2. Due to the price elasticity of demand being proportional to the ratio of price
and quantity (P/Q), as we progress down the demand curve, the price
decreases while the quantity increases, thus changing the ratio, and
decreasing the value of the price elasticity of demand.
3. An increase in the price of a good will decrease the total expenditure on that
good whilst that good has an elastic demand, or when elasticity is > 1.
4. The price elasticity of demand for a good with respect to its own price ignores
the algebraic sign because the sign will always be a negative, and for
simplification, the absolute value is used. The reason the sign is always a
negative is because the price and quantity of a good always travel in opposite
directions, that is, if a price is increased, the quantity will decrease, and vice
versa, and so according to the elasticity formula

P
1

Q slope

, this will

result in a difference of sign between P and Q, resulting in a final negative.

However, this is not always the case when taking the elasticity of a good with
respect to another good, as a price shift in one good may increase or
decrease the quantity of the other good, depending on whether the two
goods are substitutes or complements to each other.
5. Supply elasticity is higher in the long term as it represents a more flexible
combination of inputs, due to the longer period of time, as opposed to the
short run, in which producers may be stuck with whatever inputs they
currently have to produce their goods.
6. Because the butter has an elasticity of 0.5 (<1), it is inelastic, and so for
every 1% change in price, there will be a 0.5% change in demand in the
opposite direction. So to invoke a decrease of 10% in consumption of butter,
the price would be required to increase by 20%.

Tutorial 4 ELASTICITY

Problems
1. Using the formula for elasticity,

P
1

Q slope

, the elasticity for points A E

were determined

=
A

P
1
75 1

=
=3
Q slope 25 100
100

=
B

P
1
50 1

=
=1
Q slope 50 100
100

=
C

=
D

=
E

P
1
100 1

=
Q slope
0 100
100

P
1
25 1
1

=
= =0.3333
Q slope 75 100 3
100

P
1
0
1

=0
Q slope 100 100
100

4. Because the price elasticity of demand for a good generally increases with
the number of substitutes it has, in the area of cars, where a Subaru has
many substitutes, it is likely to be more elastic than the demand for all cars.
6. Cross-price elasticity of demand is calculated as the percentage change in
demand of a good per percentage change in price of another good. In this
case, a 2% in price of corn chips causes a 4% drop in the demanded quantity
of salsa, so the cross-price elasticity of demand of salsa is calculated to be

Qsalsa
4
=
=2
P corn chips 2

Because the cross-price elasticity is a negative, the two goods are

complements to each other.

=
7. A

=
B

P
1
4 1 4 3 2

= = = =0.66666
Q slope 9 2 9 2 3
3
P
1
6 1 1 3 3

= = = =0.75
Q slope 12 2 2 2 4
3

10.By enforcing regulations to make people buy air conditioners that are more
energy efficient, they would effectively be reducing the price of the air

Tutorial 4 ELASTICITY

conditioners to make it more attractive to buyers. If the demand is elastic, a

decrease in price would increase the total expenditure, and people may end
up using more electricity.

Tutorial 4 ELASTICITY

2. a)

=
b)

P
1
3 1 1 18 1 3 1

=
= = = =1
Q slope 9 6 3 6 3 1 1
18

c)

The total expenditure is given by the product of quantity and price. Currently
at $3 per croissant, the bakery is selling 9000 croissants, bringing the total
expenditure to $27000. If the price was to increase to $4 per croissant, the
quantity sold would drop to 6000 per day, bringing the total to $24000.
Therefore increasing the price of croissants from $3 to $4 would cause
revenues to drop by $3000.

=
d)

P
1
2 1 1 18 1 3 1

=
= = = =0.5
Q slope 12 6 6 6 6 1 2
18

e)

The total expenditure is given by the product of quantity and price. Currently
at $2 per croissant, the bakery is selling 12000 croissants, bringing the total
expenditure to $24000. If the price was to increase to $3 per croissant, the

Tutorial 4 ELASTICITY

quantity sold would drop to 9000 per day, bringing the total to $27000.
Therefore increasing the price of croissants from $2 to $3 would cause
revenues to increase by $3000.

Tutorial 4 ELASTICITY