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Worksheet

4 ELASTICITY

1. Define the term price elasticity of demand.


The price elasticity of demand is the absolute value of the percent change in the quantity
demanded divided by the percent change in price. It measures the responsiveness of quantity
demanded to changes in price.

2. For what range of values of elasticity is demand said to be elastic? For what range is it inelastic?
Demand is elastic if the elasticity is greater than one. It is inelastic if the elasticity is less than
one.

3. The New Millennium Dome Company (NMDC) must choose the entry fee for a new sports arena. Suppose
an expensive consultancy firm has estimated the demand schedule to be as follows:

Price of ticket Visitors


(dollars) (millions)
36 10
30 15
24 20
18 25
12 30
6 35

a. Compute the price elasticity of demand for the range P = $30 to P = $24 and for the range P = $18 to P =
$12.

The price elasticity of demand for the first price range is 1.29. The price elasticity of demand
for the second price range is 0.45.
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b. The current admission price is $18. If NMDC wants to increase its total revenue, should it charge a lower
or higher price?

It should charge a higher price. Because the elasticity is less than one when P=18, an increase
in the price will increase its total revenue.

4. The price elasticity of demand is a measure of the responsiveness of quantity demanded to changes in price.
Demand for a product or service is more responsive (that is, more elastic) as the number and closeness of
substitutes for that good or service rises, and as the importance of the item in a persons budget increases.
Suppose a seller knows that some customers have fewer substitutes (less elastic demand) than others. In some
situations the seller can increase his or her profit by charging a higher price to those customers whose demand
for the product is less elastic, and a lower price to those with more elastic demand. With this result in mind,
answer the following questions:
a. Why do airlines charge business travelers higher prices than tourists?

Business travelers typically have much less discretion over when they travel. The need to be at
their destination in time for meetings or conferences means that their options are severely
restricted. With fewer substitutes, business travelers are charged the higher price.

b. Why are gasoline prices higher at stations located on interstate highways than those off the interstate?

Motorists traveling from city to city are less likely to have information about the location of
other service stations than locals. As a result, travelers do not have many substitutes and so
they wind up paying a higher price.