Tutorial 5

Section B:Essay
Questions
 Question 1
Compute and interpret the elasticity for each of
the following :
a) Assume that the price of Good B has risen by 10 percent and
the quantity demanded of Good A decreases by 20 percent.

% change in quantity demanded of one good

Ec = % change in price of another good

= % Qd good B
%Pgood A
20%
= 10%

= -2
Since Ec < 0, both Good A and Good B are complement.
b) Recently, in Newtown, the price of Good C fell from RM0.80 to
RM0.70. As a result, the quantity demanded of Good D 's decreased
from 120 units to 100 units.
Price (RM)

Quantity demanded (units)

 %  Quantity demanded of good D
Ed =
%  Price of good C
1 0 01 2 0100
= 120
0.7 00.8 0100
0 .8 0
= 1.333

• Since Ed > 0, both Good C and Good D are substitutes .

• %∆QdD moves in the same direction as the %∆PC.

• The higher the EC, the greater the degree of substitution.

Question 2
 2a) Define cross elasticity of demand and
show how it is measured.
• Cross elasticity of demand measures the
responsiveness in the quantity demanded of one good
to the changes in the price of another good .
• To determine whether two goods are substitutes or
complements and their degree of substitutability or
complementarity.
 Formula of cross elasticity of demand
 
Cross elasticity of demand (Ec)
=
Positive cross elasticity of demand (Ec>0)
• When goods are substitute of each other then cross
elasticity of demand is positive.

• In other words, when an increase in the price of Y

leads to an increase in the demand of X . The
percentage change in the quantity demanded of one
good moves in the same direction as the percentage
change in the price of another good.
Negative cross elasticity of demand (Ec<0)
• In the case of complementary goods, cross elasticity
of demand is negative.

• A proportionate increase in price of one good leads to

a proportionate fall in the demand of another good
because both are demanded jointly. The percentage in
the quantity demanded of one good moves in opposite
direction as the percentage change in the price of
another good.
2b) If the coefficient of cross elasticity of demand
between good A and good B is negative , interpret
the relationship between these two goods.
• Good A and Good B are complements.
• When the price of good A increases , the quantity of demanded of
good A decreases.
• The demand of good B decreases.
• The percentage change in the quantity demanded of good A moves in
opposite direction as the percentage change in the price of good B.
• The relationship between price of good A and demand of good B is
negative.
Question 3
 a) Definition of Price Elasticity of Supply
••  Measuresthe responsiveness of a change in
quantity supplied to a change in good’s own price.
• The formula for price elasticity of supply is:
Es=
 5 Types of Price Elasticity of Supply
• Elastic Supply (Es>1)
% change in quantity supplied is larger than % change in prices
etc: manufactured goods
Price (RM)

S
11
10%
 Es =
10
= 2

20%

0 Quantity supplied (unit)

100 120
• Inelastic supply (Es<1)
% change in quantity supplied is smaller than % change in prices
etc: agricultural goods
Price (RM)

12

20%  Es =
= 0.5
10

10%
Quantity supplied (unit)
0 100 110
• Unit Elastic Supply (Es=1)
% change in quantity supplied is equal to % change in prices
Price (RM)

11
 Es =
10% = 1

10

10%

Quantity Supplied (unit)

0 100 110
  
• Perfectly Elastic Supply (Es=)
Supplier will be willing to supply any amount at a given price but none
at a different price.
Price (RM)

10

Quantity Supplied (unit)

0 200
• Perfectly Inelastic Supply (Es=0)
As the price changes, the quantity supplied doesn’t change.
Price (RM)

 Es =
11
= 0
10%

10

Quantity supplied (unit)

0 100
 b) Is the price elasticity of supply usually larger
in the short run or long run?
• Price elasticity of supply is usually larger in the long run.
• The more time given to the producers to respond to the price
changes, the more elastic the supply.
• In the long run, producers have more time to adjust their
production levels and manage their resources effectively in
order to expand their production.
• For example, in the long run, when the price of good goes up,
the producer can increases the usage of labour and capital to
increase output.
 c) Distinguish between ‘positive’ and ‘negative’
income elasticity of demand.
Positive income elasticity of demand Negative income elasticity of demand
Normal Good (E>0) Inferior Good (E<0)
When income increases, the demand for the normal When income increases, the demand for inferior good
good increases. Therefore, the income elasticity decreases. Therefore, the income elasticity demand is
demand is positive. negative.
i. Luxury good (income elastic)
- income elasticity demand, E>1
- this means % > %Y(income)
- Example: Jewelry, mobile phone, wine

ii. Necessity Good (income inelastic)

- income elasticity demand 0< E <1
- this means % < %Y(income)
- Example: water, medicine
Question 4
4.a)Using the midpoint method, answer the following
question:
An increase in the price of chocolates from RM2.25
to RM2.45 causes suppliers of chocolates to increase
their quantity supplied from 125 bags per minute to
145 bags per minute.
Calculate and interpret the price elasticity of supply.
 percentage change in quantity supplied
Eₛ  percentage change in price
Qs
Q s average

P
P average
145  125
145  125
 2
2 . 45  2 . 25
2 . 45  2 . 25
2
 1 . 74

Interpretation:
The price elasticity of supply (Eₛ) is 1.74. Since Eₛ>1, the supply of
chocolates is elastic. The percentage change in quantity supplied is
greater than the percentage change in price.
4.b)Distinguish between “income
elasticity of demand” and “cross
elasticity of demand”.
Income Elasticity of Demand Cross Elasticity of Demand
A measure of the responsiveness A measure of the responsiveness
of quantity demanded to changes in quantity demanded of one good
in income to changes in the price of another
good
percentage change in quantity
EY percentage
change
in EC
quantity
demanded demanded of one good
 
percentage
change
in
income percentage change in price
of another good
used to distinguish between to determine whether two goods
normal and inferior goods are substitutes for or complements
to each other or unrelated
Income Elasticity of Demand
If EY>0:
• the good is normal good
• the demand of normal good
increases as income increases,
and vice versa
If EY<0:
• the good is inferior good
• the demand of inferior good
decreases as income increases,
and vice versa
Cross Elasticity of Demand
If EC>0:
• two goods (good A and good B)
are substitutes
• %∆QdA moves in the same
direction as the %∆PB
If EC>0:
• two goods (good A and good B)
are complements
• %∆QdA moves in the opposite
direction as the %∆PB
If income elastic (EY>1):
• %∆Qd>%∆Y
• normally happens for luxury goods

If income inelastic (EY<1):

• %∆Qd<%∆Y
• normally happens for necessities

If income unit elastic (EY=1):

• %∆Qd=%∆Y
Question 5
5. Using the midpoint method, compute and explain the
coefficient of income elasticity of demand (Ey) for each
of the following:

(i) The quantity demanded of Italian sports car increases from 100 to
123 as total income rises from RM4,877 million to RM5,705 million.

(ii) Garrett buys 12 bottles of yogurt drink per month when his monthly
income is RM3,000. When his income decreases to RM2,500 a
month later, he buys 2 extra bottles of yogurt drink.
Income Elasticity of Demand
(Ey)
• Income elasticity of demand is use to measures the
responsiveness of quantity demanded to changes in
income.

Meaning:
Responsiveness is the quality of having a reaction to
something or someone, especially a quick or positive
reaction.
By using the midpoint method:
•Formula:
 

Ey
•(i)
  Qd1 = 100 Y1 = RM4,877 million
Qd2 = 123 Y2 = RM5,705 million
Qd2Qd1

Interpretation : Since the income elasticity of demand of Italian sport car is positive,
therefore it is a normal good as when the income increases, the
demand for the sport car increases as well. The income elasticity of
demand of Italian sport car is greater than 1, thus it is also a luxury
good.
 •   Qd1 = 12
(ii) Y1 = RM3,000
Qd2 = 14 Y2 = RM2,500
Qd2Qd1

2500

Interpretation : Since the income elasticity of demand of the yogurt drink is

negative,
it is an inferior good as an increase in income leads to fall in
demand.
Question 6
6. When the price of McRonald’s burger falls
from RM16 to RM14, the quantity demanded
increase from 200 to 300 burgers per month.
On the other hand, the demand for Burger
Queen falls from 250 to 200 burgers per month.
i. Based on the situation above, calculate the price
elasticity of demand for McRonald’s burger by using the
midpoint formula.

Elasticity of demand =

Midpoint formula
 
Percentage change in quantity = × 100

Percentage change in price = × 100

*The advantage of the midpoint method is that one obtains

the same elasticity between two price points whether there
is a price increase or decrease. This is because the formula
uses the same base for both cases.
Answer :

Percentage change in quantity = × 100

= 40

Percentage change in price = × 100  

= 13.33

Elasticity of demand =

=3
*Price elasticity of demand are always negative, since price and
quantity demanded always move in opposite directions (on the demand
curve). As you’ll recall, according to the law of demand, price and
quantity demanded are inversely related. By convention, we always
talk about elasticity as positive numbers, however. So, mathematically,
we take the absolute value of the result. For example, -3 would
interpreted as 3.
ii. If the price of McRonald’s burger increase, describe the
effects on McRonald’s total revenue.

-The price elasticity of demand is 3.So the Ed is elastic. The

price of McRonald’s burger increase by 1%, quantity
demanded for McRonald’s burger reduces by 3%.

- Percentage change in Quantity demand greater than the

percentage change in price.

- price ↑ quantity demand ↓

- So the total revenue will decrease

iii. Calculate the cross elasticity of demand between
McRonald’s and Burger Queen burger. Interpret the results.

- Percentage change in quantity demanded of Burger

Queen
= × 100

= −22.22
 
- Percentage change in price of McRonald Burger
= × 100

= 13.33
-Cross Elasticity of demand =

= 1.6669
 
As a result, the relationship between McRonald’s burger
and Burger Queen burger is considered as substitutes since
Ec is positive.