ECONOMICS MICHAEL PARKIN ANSWERS
- Why do we need a units-free measure of the responsiveness of the
quantity demanded of a good or service to a change in its price?
The elasticity of demand is a units-free measure. Compare it as a
measure of the responsiveness to some other candidate that depends
on the units, such as the slope. The slope of the demand curve
changes as the units measuring the same quantity of the good change
(going from pounds to ounces, for example). The value of the
elasticity is independent of the units used to measure the price and
quantity of the product. As a result, the elasticity can be compared
across the same good when quantity is measured in different units
and/or the price is measured in different currencies. The
elasticities of different goods also can be compared even though
they are measured in different units. - Define the price elasticity of demand and show how it is
calculated.
The price elasticity of demand is units-free measure of the
responsiveness of the quantity demanded of a good to a change in its
price when all other influences on buying plans remain the same. It
equals the absolute value (or magnitude) of the ratio of the
percentage change in the quantity demanded to the percentage change
in the price. The percentage change in quantity (price) is measured
as the change in quantity (price) divided by the average quantity
(price). - What makes the demand for some goods elastic and the demand for
other goods inelastic?
The magnitude of the price elasticity of demand for a good depends
on three main influences:
Closeness of substitutes. The more easily people can substitute
other items for a particular good, the larger is the price
elasticity of demand for that good.
The proportion of income spent on the good. The larger the
portion of the consumer’s budget being spent on a good, the
greater is the price elasticity of demand for that good.
The time elapsed since a price change. Usually, the more time
that has passed after a price change, the greater is the price
elasticity of demand for a good.
4
C h a p t e r ELASTICITY
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6 4 C H A P T E R 4 - Why is the demand for a luxury generally more elastic (or less
inelastic) than the demand for a necessity?
Demand for a necessity is generally less elastic than demand for a
luxury because there are fewer substitutes for a necessity. Because
there are more substitutes for a luxury than a necessity, the
elasticity of demand for a luxury is larger is than the elasticity
of demand for a necessity. - What is the total revenue test?
The total revenue test is a method of estimating the price
elasticity of demand by observing the change in total revenue, given
a change in price, holding all other things constant. The total
revenue test shows that a price cut increases total revenue if
demand is elastic, decreases total revenue if demand is inelastic,
and does not change total revenue if demand is unit elastic.
Page 94 - What does the income elasticity of demand measure?
The income elasticity of demand measures how the quantity demanded
of a good responds to a change in income. The formula for the income
elasticity of demand is the percentage change in the quantity of the
good demanded divided by the percentage change in income. - What does the sign (positive/negative) of the income elasticity
tell us about a good?
The sign of the income elasticity of demand reveals whether a good
is a normal good or an inferior good: The income elasticity of
demand is positive for normal goods and negative for inferior goods. - What does the cross elasticity of demand measure?
The cross elasticity of demand measures how the quantity demanded of
one good responds to a change in the price of another good. The
formula for the cross elasticity of demand is the percentage change
in the quantity of the good demanded divided by the percentage
change in the price of the related good. - What does the sign (positive/negative) of the cross elasticity of
demand tell us about the relationship between two goods?
The sign of the cross elasticity of demand reveals whether two goods
are substitutes or compliments: The cross elasticity of demand is
positive for substitutes and negative for complements.
Page 96 - Why do we need a units-free measure of the responsiveness of the
quantity supplied of a good or service to a change in its price?
The elasticity of supply is a units-free measure. We need a unitsfree measure of the elasticity of supply for the same reason we need
a units-free measure of the elasticity of demand: Because the value
of the elasticity of supply is independent of the units used to
measure the price and quantity of the good, the elasticity of supply
can be compared across the same good when quantity is measured in
different units and/or the price is measured in different
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E L A S T I C I T Y 6 5
currencies. In addition, the elasticities of supply of different
goods also can be compared even though they are measured in
different units. - Define the elasticity of supply and show how it is calculated.
The elasticity of supply measures the responsiveness of the quantity
supplied to a change in the price of a good when all other
influences on selling plans remain the same. The elasticity of
supply is calculated by the percentage change in the quantity
supplied divided by the percentage change in the price. - What are the main influences on the elasticity of supply that
make the supply of some goods elastic and the supply of other
goods inelastic?
The main influences on the elasticity of supply are:
Resource substitution possibilities: the greater the suppliers’
ability to substitute resources, the greater will be their
ability to react to price changes and the greater the elasticity
of supply.
Time frame for the supply decision: the greater the amount of
time available after the price change, the greater is the
suppliers’ ability to adjust quantity supplied, and the greater
the elasticity of supply. - Provide examples of goods or services whose elasticities of
supply are (a) zero, (b) greater than zero but less than
infinity, and (c) infinity.
Here are some examples:
a) The momentary supply of wheat is perfectly inelastic. Once
farmers have brought their wheat to market, there is no other
alternative use for it and they sell it all regardless of the
going price.
b) The short-run supply of wheat. If the farmers already have a
mature wheat crop but have not yet harvested it, farmers with
both relatively high and low yield fields may chose to harvest
both types of fields if the price for wheat is high. However, the
farmers will not harvest their low yield fields when the price of
wheat is relatively low to economize on added labor costs.
c) The supply of wheat to an individual buyer. Any one buyer can
purchase as much wheat at the going price as he or she desires.
However, no quantity of wheat will be supplied at a lower price. - How does the time frame over which a supply decision is made
influence the elasticity of supply? Explain your answer.
The momentary supply, short-run supply, and long-run supply all
illustrate the response of suppliers to changes in the price, but
they differ according to how much time has elapsed after the price
change.
The momentary supply is frequently the least elastic and shows
how suppliers cannot easily respond to a price change immediately
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6 6 C H A P T E R 4
after the price change occurs. Changing the quantity produced
means changing the inputs into the production process, which
takes time to complete. Sometimes the momentary supply is
perfectly inelastic.
The short-run supply shows suppliers’ response after enough time
has elapsed for some, but not all, of the possible technological
adjustments have occurred. Short-run supply generally is
intermediate in elasticity between the momentary supply and the
long-run supply.
The long-run supply shows how suppliers react after enough time
has passed that all possible adjustments to factors of production
have been made to accommodate the price change. It usually is the
most elastic of the three supplies.
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E L A S T I C I T Y 6 7
Answers to the Study Plan Problems and Applications - Rain spoils the strawberry crop, the price rises from $4 to $6 a
box, and the quantity demanded decreases from 1,000 to 600 boxes
a week.
a. Calculate the price elasticity of demand over this price range.
The price elasticity of demand is 1.25. The price elasticity of
demand equals the percentage change in the quantity demanded divided
by the percentage change in the price. The price rises from $4 to $6
a box, a rise of $2 a box. The average price is $5 a box. So the
percentage change in the price is $2 divided by $5 and then
multiplied by 100, which equals 40 percent. The quantity decreases
from 1,000 to 600 boxes, a decrease of 400 boxes. The average
quantity is 800 boxes. So the percentage change in quantity is 400
divided by 800, which equals 50 percent. The price elasticity of
demand for strawberries is 50 percent divided by 40 percent, which
equals 1.25.
b. Describe the demand for strawberries.
The price elasticity of demand exceeds 1, so the demand for
strawberries is elastic. - If the quantity of dental services demanded increases by 10
percent when the price of dental services falls by 10 percent, is
the demand for dental services inelastic, elastic, or unit
elastic?
The demand for dental services is unit elastic. The price elasticity
of demand for dental services equals the percentage change in the
quantity of dental services demanded divided by the percentage
change in the price of dental services. The price elasticity of
demand is 10 percent divided by 10 percent, which equals 1. The
demand is unit elastic. - The demand schedule for hotel
rooms is in the table.
a. What happens to total revenue
when the price falls from $400
to $250 a night and from $250
to $200 a night?
When the price is $400, the total
revenue is equal to $400 × 50
million rooms, or $20 billion.
When the price is $250, the total
revenue is equal to $250 × 80
million rooms, or $20 billion. So the total revenue does not change
when the price falls from $400 to $250 a night.
When the price is $250, the total revenue is equal to $250 × 80
million rooms, or $20 billion. When the price is $200, the total
revenue is equal to $200 × 100 million rooms, or $20 billion. So the
total revenue does not change when the price falls from $400 to $250
a night.
b. Is the demand for hotel rooms elastic, inelastic or unit
Price
(dollars
per night)
Quantity
demanded
(millions of
rooms per
night)
200 100
250 80
400 50
500 40
800 25
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6 8 C H A P T E R 4
elastic?
The total revenue is the same at all prices, $20 billion. Because a
change in price does not change the total revenue at any price, the
demand is unit elastic at all prices.
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E L A S T I C I T Y 6 9 - The figure shows the demand for
pens.
Calculate the elasticity of
demand when the price rises from
$4 to $6 a pen. Over what price
range is the demand for pens
elastic?
The price elasticity of demand is
0.72. When the price of a pen
rises from $4 to $6, the quantity
demanded of pens decreases from
80 to 60 a day. The price
elasticity of demand equals the
percentage change in the quantity
demanded divided by the
percentage change in the price.
The price increases from $4 to
$6, an increase of $2 a pen. The
average price is $5 per pen. So
the percentage change in the price equals $2 divided by $5 and then
multiplied by 100, which equals 40 percent. The quantity decreases
from 80 to 60 pens, a decrease of 20 pens. The average quantity is
70 pens. So the percentage change in quantity demanded equals 20
divided by 70 and then multiplied by 100, which equals 28.6 percent.
The price elasticity of demand for pens equals 28.6 percent divided
by 40 percent, which is 0.72.
The demand for pens is elastic at all prices higher than the price
at the midpoint of the demand curve, which indicates that the demand
for pens is elastic at prices between $12 per pen and $6 per pen. - In 2003, when music downloading first took off, Universal Music
slashed the average price of a CD from $21 to $15. The company
expected the price cut to boost the quantity of CDs sold by 30
percent, other things remaining the same.
a. What was Universal Music’s estimate of the price elasticity of
demand for CDs?
Using the data in the question, the price elasticity of demand is
0.90. The change in the price is $6 and the average of the two
prices is $18, so the percentage change in the price is ($6/$18)
100, which equals 33.3 percent. The increase in the quantity
demanded was estimated to be 30 percent. The price elasticity of
demand equals (30.0 percent)/(33.3 percent), or 0.90.
b. If you were making the pricing decision at Universal Music, what
would be your pricing decision? Explain your decision.
The demand is inelastic, so if nothing else changes the price cut
leads to a decrease in Universal Music’s total revenue. However,
downloaded music and CDs are substitutes for each other and the
quantity of downloaded music was forecast to rise substantially.
Effectively, the price of downloading music fell as more people
gained access to the Internet and download sites proliferated. The
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7 0 C H A P T E R 4
fall in the price of the substitute, downloaded music, decreases the
demand for Universal Music’s CDs, so the decision to cut prices most
likely was forced as the result of the (forecasted) decrease in
demand for CDs. - The demand for illegal drugs is inelastic. Much of the
expenditure on illegal drugs comes from crime. Assuming these
statements to be correct,
a. How will a successful campaign that decreases the supply of
drugs influence the price of illegal drugs and the amount spent
on them?
By decreasing the supply, the price of illegal drugs will rise.
Because the demand is inelastic, the total amount spent on them will
increase.
b. What will happen to the amount of crime?
On the one hand, purchasing illegal drugs is a criminal activity so
decreasing the amount of illegal drugs bought and sold decreases
crime. On the other hand, many consumers of illegal drugs turn to
criminal activities to raise the funds necessary to purchase the
drugs. Because the total expenditure on these drugs would increase,
the total amount of crime necessary to raise these funds would
increase.
c. What is the most effective way of decreasing the quantity of
illegal drugs bought and decreasing the amount of drug-related
crime?
If drug users are penalized, then the demand for illegal drugs
decreases, so that both the price and quantity of illegal drugs
falls. The total expenditure on illegal drugs also falls. The
decrease in the quantity of illegal drugs purchased directly reduces
the crime rate. Because the total expenditure spent on illegal drugs
falls, less crime would be necessary to raise these funds, so the
crime rate also falls, albeit indirectly. - The Grip of Gas
U.S. drivers are ranked as the least sensitive to changes in the
price of gasoline. For example, if the price rose from $3 to $4
per gallon and stayed there for a year U.S. purchases of gasoline
would fall only about 5 percent.
Source: Slate, September 27, 2005
a. Calculate the price elasticity of demand for gasoline. Is the
demand for gasoline elastic, unit elastic, or inelastic?
The price rises by $1.00 and the average price is $3.50. So the
percentage change in the price is ($1.00/$3.50) × 100, which equals
28.6 percent. The news story says that the change in the quantity
demanded is 5 percent. So the price elasticity of demand is (5
percent)/(28.6 percent), or 0.17.
Because the elasticity of demand is less than 1, the demand for
gasoline is inelastic.
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E L A S T I C I T Y 7 1
b. Explain how the price rise from $3 to $4 a gallon changes the
total revenue from gasoline sales.
If the price of gasoline rises, because the demand is inelastic the
total revenue test concludes that the total revenue from gasoline
will increase. - Spam Sales Rise as Food Costs Soar
Sales of Spam are rising as consumers realize that Spam and other
lower-cost foods can be substituted for costlier cuts of meat as
a way of controlling their already stretched food budgets.
Source: AOL Money & Finance, May 28, 2008
a. Is Spam a normal good or an inferior good? Explain.
Based on the story, Spam is probably an inferior good. The idea of
“stretched food budgets” implies that consumers’ incomes have
fallen. And, as a result, the demand for Spam increased. The demand
for Spam increased when income decreased, so Spam is an inferior
good.
b. Would the income elasticity of demand for Spam be negative or
positive? Explain.
If Spam is an inferior good, its income elasticity of demand is
negative. When income increases, the demand decreases so the income
elasticity of demand divides a negative number (the decrease in
demand) by a positive number (the increase in income) thereby
resulting in a negative value for the income elasticity of demand. - When Judy’s income increased from $130 to $170 a week, she
increased her demand for concert tickets by 15 percent and
decreased her demand for bus rides by 10 percent. Calculate
Judy’s income elasticity of demand for (a) concert tickets and
(b) bus rides.
The income elasticity of demand for (a) concert tickets is 0.56 and
(b) bus rides is −0.375. The income elasticity of demand equals the
percentage change in the quantity demanded divided by the percentage
change in income. The change in income is $40 and the average income
is $150, so the percentage change in income equals 26.7 percent.
a. The change in the quantity demanded of concert tickets is 15
percent. The income elasticity of demand for concert tickets equals
15/26.7, which is 0.56.
b. The change in the quantity demanded of bus rides is 10 percent. The
income elasticity of demand for bus rides equals 10/26.7, which is
0.375. - If a 12 percent rise in the price of orange juice decreases the
quantity of orange juice demanded by 22 percent and increases the
quantity of apple juice demanded by 14 percent, calculate the
a. Price elasticity of demand for orange juice.
The price elasticity of demand for orange juice is 1.83. The price
elasticity of demand is the percentage change in the quantity
demanded of the good divided by the percentage change in the price
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7 2 C H A P T E R 4
of the good. So the price elasticity of demand equals 22 percent
divided by 12 percent, which is 1.83.
b. Cross elasticity of demand for apple juice with respect to the
price of orange juice.
The cross elasticity of demand between orange juice and apple juice
is 1.17. The cross elasticity of demand is the percentage change in
the quantity demanded of one good divided by the percentage change
in the price of another good. So the cross elasticity of demand is
the percentage change in the quantity demanded of apple juice
divided by the percentage change in the price of orange juice. The
cross elasticity equals 14 percent divided by 12 percent, which is
1.17. - If a 5 percent rise in the price of sushi increases the quantity
of soy sauce demanded by 2 percent and decreases the quantity of
sushi demanded by 1 percent, calculate the
a. Price elasticity of demand for sushi.
The price elasticity of demand for sushi equals 1/5, which is 0.2.
b. Cross elasticity of demand for soy sauce with respect to the
price of sushi.
The cross elasticity of demand for soy sauce with respect to the
price of sushi equals 2/5, which is 0.4. - Swelling Textbook Costs Have College Students Saying ‘Pass’
Textbook prices have doubled and risen faster than average prices
for the past two decades. Sixty percent of students do not buy
textbooks. Some students hunt for used copies and sell them back
at the end of the semester; some buy online, which is often
cheaper than the campus store; some use the library copy and wait
till it’s free; some share the book with a classmate.
Source: Washington Post, January 23, 2006
Explain what this news clip implies about
a. The price elasticity of demand for college textbooks.
The news clip discusses ways students decrease the quantity of
textbooks demanded when the price of a textbook rises. It is not
possible to determine the precise elasticity of demand for
textbooks, but there are substitutes for textbooks listed. In
particular, a number of substitutes listed (borrowing, copying,
using a library copy) enable students to completely avoid buying
textbooks. Additionally other substitutes listed (buying used books,
selling books, buying on the Internet) enable students to pay less
for their textbooks. The fairly long list of good substitutes
indicates that the demand for textbooks might be elastic.
b. The income elasticity of demand for college textbooks.
The income elasticity of demand measures how the quantity demanded
changes when income changes. The news clip does not directly give
any information about changes in income, so the news clip fives no
information about the income elasticity of demand for college
textbooks.
c. The cross elasticity of demand for college textbooks from the
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E L A S T I C I T Y 7 3
campus bookstore with respect to the online price of a textbook.
The cross elasticity of demand for textbooks from campus bookstores
with respect to the online price of books is positive: the lower the
price of online books, the lower the quantity of textbooks demanded
from campus bookstores. This sign makes sense because textbooks from
campus bookstores are substitutes for textbooks from online stores.
Use the following information to work Problems 13 to 15.
As Gas Costs Soar, Buyers Flock to Small Cars
Faced with high gas prices, Americans are substituting smaller cars
for SUVs. In April 2008, Toyota Yaris sales increased 46 percent and
Ford Focus sales increased 32 percent from a year earlier. SUVs sales
decreased 25 percent in 2008 and Chevrolet Tahoe sales fell 35
percent. Full-size pickup sales decreased 15 percent in 2008 and Ford
F-Series pickup sales decreased by 27 percent in April 2008. The
effect of a downsized vehicle fleet on fuel consumption is unknown.
In California in January 2008, gasoline consumption was 4 percent
lower and the price of gasoline 30 percent higher than in January
2007.
Source: The New York Times, May 2, 2009 - Calculate the price elasticity of demand for gasoline in
California.
The price elasticity of demand equals the percentage change in the
quantity demanded divided by the percentage change in the price of
the good. Based on the data in the problem and assuming that the
demand curve for gasoline in California did not change, then the
price elasticity of demand for gasoline in California equals (4
percent/30 percent), which equals 0.13. If the downsized fleet
shifted the demand curve for gasoline leftward, then the price
elasticity of demand just calculated is too large because it
includes the decrease in the quantity demanded from the higher price
of gasoline plus the decrease in the quantity from the more fuel
efficient fleet. - Calculate the cross elasticity of demand for
a. Toyota Yaris with respect to the price of gasoline.
The cross elasticity of demand for a Toyota Yaris with respect to
the price of gasoline equals the percentage change in the quantity
demanded of Toyotas divided by the percentage change in the price of
gasoline. Based on the data in the problem and assuming that the
demand curve for these cars did not change, then the cross
elasticity of demand equals (46 percent/30 percent), which equals
1.53.
b. Ford Focus with respect to the price of gasoline.
The cross elasticity of demand for a Ford Focus with respect to the
price of gasoline equals the percentage change in the quantity
demanded of Fords divided by the percentage change in the price of
gasoline. Based on the data in the problem and assuming that the
demand curve for these cars did not change, then the cross
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elasticity of demand equals (32 percent/30 percent), which equals
1.07. - Calculate the cross elasticity of demand for
a. Chevrolet Tahoe with respect to the price of gasoline.
The cross elasticity of demand for a Chevrolet Tahoe with respect to
the price of gasoline equals the percentage change in the quantity
demanded of Chevrolets divided by the percentage change in the price
of gasoline. Based on the data in the problem and assuming that the
demand curve for these cars did not change, then the cross
elasticity of demand equals (35 percent/30 percent), which equals
1.17.
b. A full-size pickup with respect to the price of gasoline.
The cross elasticity of demand for a full-size pickup with respect
to the price of gasoline equals the percentage change in the
quantity demanded of these trucks divided by the percentage change
in the price of gasoline. Based on the data in the problem and
assuming that the demand curve for these trucks did not change, then
the cross elasticity of demand equals (15 percent/30 percent),
which equals 0.50. - Home Depot Earnings Hammered
As gas and food prices increased and home prices slumped, people
had less extra income to spend on home improvements. And the
improvements that they made were on small inexpensive types of
repairs and not major big-ticket items.
Source: CNN, May 20, 2008
a. What does this news clip imply about the income elasticity of
demand for big-ticket home-improvement items?
The news clip implies that the income elasticity of demand for bigticket home-improvement items is positive. In particular “people
have less extra income to spend” and, as a result, “fewer people are
spending money to renovate their homes.”
b. Would the income elasticity of demand be greater or less than 1?
Explain.
The income elasticity of demand is probably greater than 1. Home
remodeling is not a necessity; it is more of a luxury. The income
elasticity of demand for luxuries is greater than 1. - The table sets out the supply
schedule of jeans.
Calculate the elasticity of supply
when
a. The price rises from $125 to $135
a pair.
The elasticity of supply equals the
percentage change in the quantity
supplied divided by the percentage
change in price. The percentage
change in the quantity demanded equals [(36 28)/32] × 100, which is
25.0 percent. The percentage change in the price equals [($135
Price
(dollars
per pair)
Quantity
supplied
(millions of
pairs per
year)
120 24
125 28
130 32
135 36
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E L A S T I C I T Y 7 5
$125)/$130] × 100, which is 7.7 percent. The elasticity of supply
equals (25.0 percent/7.7 percent), which is 3.25.
b. The average price is $125 a pair.
To find the elasticity at an average price of $125 a pair, change
the price such that $125 is the average price—for example, a rise in
the price from $120 to $130 a pair. To calculate the elasticity when
the average price is $125, calculate the elasticity over the price
range from $120 to $130. The percentage change in the quantity
demanded equals [(32 24)/28] × 100, which is 28.6 percent. The
percentage change in the price equals [($130 $120)/$125] × 100,
which is 8.0 percent. The elasticity of supply equals (28.6
percent/8.0 percent), which is 3.58. - Study Ranks Honolulu Third Highest for “Unaffordable Housing”
A study ranks Honolulu number 3 in the world for the most
unaffordable housing market in urban locations, behind Los
Angeles and San Diego and is deemed “severely unaffordable.” With
significant constraints on the supply of land for residential
development, housing inflation has resulted.
Source: Hawaii Reporter, September 11, 2007
a. Would the supply of housing in Honolulu be elastic or inelastic?
The supply of housing is probably inelastic because it is limited by
the amount of land, which is inelastically supplied. Indeed, the
elasticity of supply for housing is probably close to 0.
b. Explain how the elasticity of supply plays an important role in
influencing how rapidly housing prices in Honolulu rise.
The less elastic the supply, the more an increase in demand raises
the price. Because the supply of housing is quite inelastic in
Honolulu, increases in demand for housing have lead to large
increases in the price of housing, that is, severe “housing
inflation.”
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Answers to Additional Problems and Applications - With higher fuel costs, airlines raised their average fare from
75¢ to $1.25 per passenger mile and the number of passenger miles
decreased from 2.5 million a day to 1.5 million a day.
a. What is the price elasticity of demand for air travel over this
price range?
The price elasticity of demand equals the percentage change in the
quantity demanded divided by the percentage change in the price. The
quantity demanded changes by 1.0 million passenger miles and the
average passenger miles is 2.0 million. The percentage change in the
quantity demanded is (1.0 million)/(2.0 million) 100, which is 50
percent. The price changes by $0.50 and the average price is $1.00.
The percentage change in the quantity demanded is ($0.50 /($1.00)
100, which is 50 percent. So the price elasticity of demand is (50
percent)/(50 percent), or 1.00.
b. Describe the demand for air travel.
The demand for air travel between these two prices is unit elastic.
The 50 percent price hike leads to a 50 percent decrease in the
quantity of air miles traveled. - Figure 4.2 shows the demand for DVD rentals.
a. Calculate the elasticity of
demand when the price of a DVD
rental rises from $3 to $5.
The price elasticity of demand is - When the price of a DVD rental
rises from $3 to $5, the quantity
demanded of DVDs decreases from
75 to 25 a day. The price
elasticity of demand equals the
percentage change in the quantity
demanded divided by the
percentage change in the price.
The price increases from $3 to
$5, an increase of $2 a DVD. The
average price is $4 per DVD. So
the percentage change in the
price equals $2 divided by $4 and
then multiplied by 100, which
equals 50 percent. The quantity
decreases from 75 to 25 DVDs, a decrease of 50 DVDs. The average
quantity is 50 DVDs. So the percentage change in quantity demanded
equals 50 divided by 50 and then multiplied by 100, which equals 100
percent. The price elasticity of demand for DVD rentals equals 100
percent divided by 50 percent, which is 2.
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E L A S T I C I T Y 7 7
b. At what price is the elasticity of demand for DVD rentals equal
to 1?
The price elasticity of demand equals 1 at $3 a DVD. The price
elasticity of demand equals 1 at the price halfway between the
origin and the price at which the
demand curve intersects
the y-axis. That price is $3 a DVD.
Use the following table to work
Problems 21 to 23.
The demand schedule for computer
chips is in the table. - a. What happens to total
revenue if the price falls from
$400 to $350 a chip and from
$350 to $300 a chip?
When the price of a chip is $400, 30 million chips are sold and
total revenue equals $12,000 million. When the price of a chip falls
to $350, 35 million chips are sold and total revenue is $12,250
million. The total revenue increases when the price falls.
When the price is $350 a chip, 35 million chips are sold and total
revenue is $12,250 million. When the price of a chip is $300, 40
million chips are sold and total revenue decreases to $12,000
million. The total revenue decreases as the price falls.
b. At what price is total revenue at a maximum?
Total revenue is maximized at $350 a chip. When the price of a chip
is $300, 40 million chips are sold and total revenue equals $12,000
million. When the price is $350 a chip, 35 million chips are sold
and total revenue equals $12,250 million. Total revenue increases
when the price rises from $300 to $350 a chip. When the price is
$400 a chip, 30 million chips are sold and total revenue equals
$12,000 million. Total revenue decreases when the price rises from
$350 to $400 a chip. Total revenue is maximized when the price is
$350 a chip. - At an average price of $350, is the demand for chips elastic,
inelastic, or unit elastic? Use the total revenue test to answer
this question.
The demand for chips is unit elastic. The total revenue test says
that if the price changes and total revenue remains the same, the
demand is unit elastic at the average price. For an average price of
$350 a chip, cut the price from $400 to $300 a chip. When the price
of a chip falls from $400 to $300, the total revenue remains at
$12,000 million. So at the average price of $350 a chip, demand is
unit elastic. - At $250 a chip, is the demand for chips elastic or inelastic? Use
the total revenue test to answer this question.
The demand for chips is inelastic. The total revenue test says that
if the price falls and total revenue falls, the demand is inelastic.
When the price falls from $300 to $200 a chip, total revenue
Price
(dollars
per chip)
Quantity
demanded
(millions of
chips per
year)
200 50
250 45
300 40
350 35
400 30
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7 8 C H A P T E R 4
decreases from $12,000 million to $10,000 million. So at an average
price of $250 a chip, demand is inelastic. - Your price elasticity of demand for bananas is 4. If the price of
bananas rises by 5 percent, what is
a. The percentage change in the quantity of bananas you buy?
The quantity of bananas you buy decreases by 20 percent. The price
elasticity of demand equals the percentage change in the quantity
demanded divided by the percentage change in the price. Rearranging
this formula shows that the percentage change in the quantity
demanded equals the price elasticity of demand multiplied by the
percentage change in the price. The percentage change in the
quantity demanded equals 4 5 percent, which is 20 percent.
b. The change in your expenditure on bananas?
Your total expenditure decreases because your demand is elastic. The
fall in expenditure is approximately 15 percent, the 5 percent rise
in price offset by the 20 percent decrease in the quantity
purchased. - As Gasoline Prices Soar, Americans Slowly Adapt
As gas prices rose in March 2008, Americans drove 11 billion
fewer miles than in March 2007. Realizing that prices are not
going down, Americans are adapting to higher energy costs.
Americans spend 3.7 percent of their disposable income on
transportation fuels. How much we spend on gasoline depends on
the choices we make: what car we drive, where we live, how much
time we spend driving, and where we choose to go. For many
people, higher energy costs mean fewer restaurant meals, deferred
weekend outings with the kids, less air travel, and more time
closer to home.
Source: International Herald Tribune, May 23, 2008
a. List and explain the elasticities of demand that are implicitly
referred to in the news clip.
The elasticities to which the clip refers are the income elasticity
of demand, the price elasticity of demand, and the cross elasticity
of demand. The income elasticity of demand is reflected in the news
clip’s discussion of the fraction of income spent on transportation
fuels. More references are made to the factors that influence the
price elasticity of demand. The article lists many substitutions
households can make in response to higher fuel prices. In particular
the type of car a family can drive, where the family lives, and
where the family chooses to go reflect substitution methods that
households can use to decrease the quantity of gasoline demanded. In
addition, discussion of “fewer restaurant meals, deferred weekend
outings with the kids, less air travel and more time closer to home”
suggest that higher gasoline prices have an income effect that
decreases the quantity demanded. It is the strength of these factors
that determines the magnitude of the price elasticity of demand for
fuel. Additionally these activities, such as smaller cars, more time
closer to home, are also the substitutes that people use in place of
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E L A S T I C I T Y 7 9
gasoline. The news clips suggests that these activities increase in
response to the higher price of gasoline, indicating that they are
substitutes for gasoline so that their cross elasticity of demand
with respect to the price of gasoline is positive.
b. Why, according to the news clip, is the demand for gasoline
inelastic?
One factor listed that helps make the demand for gasoline inelastic
is the point that gasoline accounts for only a relatively small
fraction of people’s incomes. Another factor is more qualitative:
none of the substitutions listed for gasoline—the type of car the
family drives and so forth—are particularly close substitutes for
gasoline. The absence of close substitutes combined with the
relatively small fraction of income spent on gasoline combine to
make the demand for gasoline inelastic.
Use this information to work Problems 26 and 27.
Economy Forces Many to Shorten Summer Vacation Plans
This year Americans are taking fewer exotic holidays by air and
instead are visiting local scenic places by car. The global financial
crisis has encouraged many Americans to cut their holiday budgets.
Source: USA Today, May 22, 2009 - Given the prices of the two holidays, is the income elasticity of
demand for exotic holidays positive or negative? Are exotic
holidays a normal good or an inferior good? Are local holidays a
normal good or an inferior good?
The income elasticity of demand for exotic holidays is positive so
exotic holidays are a normal good. The income elasticity of demand
for local holidays is negative so local holidays are an inferior
good. - Are exotic holidays and local holidays substitutes? Explain your
answer.
Exotic holidays and local holidays are substitutes. The article
points out that in 2009 Americans were visiting local scenic places
rather than visiting exotic locations. So Americans were
substituting local holidays for exotic holidays. - When Alex’s income was $3,000, he bought 4 bagels and 12 donuts a
month. Now his income is $5,000 and he buys 8 bagels and 6 donuts
a month. Calculate Alex’s income elasticity of demand for
a. Bagels.
The income elasticity of demand equals the percentage change in the
quantity demanded divided by the percentage change in income. The
change in income is $2,000 and the average income is $4,000, so the
percentage change in income equals 50 percent. The change in the
quantity demanded is 4 bagels and the average quantity demanded is 6
bagels, so the percentage change in the quantity demanded equals
66.67 percent. The income elasticity of demand for bagels equals
(66.67 percent)/(50 percent), which is 1.33.
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8 0 C H A P T E R 4
b. Donuts.
From part (a), the percentage change in income is 50 percent. The
change in the quantity demanded is 6 donuts and the average
quantity demanded is 9 donuts, so the percentage change in the
quantity demanded is 66.67 percent. The income elasticity of demand
for donuts equals (66.67 percent)/(50 percent), which is 1.33. - Wal-Mart’s Recession-Time Pet Project
During the recession, Wal-Mart moved its pet food and supplies to
in front of its other fast growing business, baby products.
Retail experts point out that kids and pets tend to be fairly
recession-resistant businesses—even in a recession, dogs will be
fed and kids will get their toys.
Source: CNN, May 13, 2008
a. What does this news clip imply about the income elasticity of
demand for pet food and baby products?
The news clip implies that both pet food and baby food are
necessities. Their income elasticities of demand are positive but
very small (since they “tend to be fairly recession resistant
businesses”).
b. Would the income elasticity of demand be greater or less than 1?
Explain.
The income elasticities of demand are less than 1 because they are
necessities. - If a 5 percent fall in the price of chocolate sauce increases the
quantity of chocolate sauce demanded by 10 percent and increases
the quantity of ice cream demanded by 15 percent, calculate the
a. Price elasticity of demand for chocolate sauce.
The price elasticity of demand for chocolate sauce equals the
percentage change in the quantity of chocolate sauce demanded
divided by the percentage change in the price of chocolate sauce.
Using the data in the problem, the price elasticity of demand equals
(10 percent)/(−5 percent), which is 2.0.
b. Cross elasticity of demand for ice cream with respect to the
price of chocolate sauce.
The cross elasticity of demand for ice cream with respect to the
price of chocolate sauce equals the percentage change in the
quantity of ice cream demanded divided by the percentage change in
the price of chocolate sauce. Using the data in the problem, the
cross elasticity of demand equals (15 percent)/(−5 percent), which is
−3.0. Ice cream and chocolate sauce are complements. - Netflix to Offer Online Movie Viewing
Online movie rental service Netflix has introduced a new feature
to allow customers to watch movies and television series on their
personal computers. Netflix competes with video rental retailer
Blockbuster, which added an online rental service to the in-store
rental service.
Source: CNN, January 16, 2007
a. How will online movie viewing influence the price elasticity of
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E L A S T I C I T Y 8 1
demand for in-store movie rentals?
The price elasticity of demand for store rental movies will increase
because online movie viewing is a substitute for renting movies.
b. Would the cross elasticity of demand for online movies and instore movie rentals be negative or positive? Explain.
Online movies and in-store rental movies are substitutes, so their
cross elasticity of demand is positive.
c. Would the cross elasticity of demand for online movies with
respect to high-speed Internet service be negative or positive?
Explain.
Online movies and high-speed Internet service are complements, so
their cross elasticity of demand is negative. - To Love, Honor, and Save Money
In a survey of caterers and event planners, nearly half of them
said that they were seeing declines in wedding spending in
response to the economic slowdown; 12% even reported wedding
cancellations because of financial concerns.
Source: Time, June 2, 2008
a. Based upon this news clip, are wedding events a normal good or
inferior good? Explain.
Based on the news clip, wedding events are a normal good. The
economic slowdown means that people’s incomes are falling and, as a
result, the demand for wedding events is decreasing.
b. Are wedding events more a necessity or a luxury? Would the
income elasticity of demand be greater than 1, less than 1, or
equal to 1? Explain.
Wedding events are a luxury. Wedding events are not necessities
because couples can marry with plain weddings; indeed, couples can
marry using a civil ceremony and with no wedding event at all. If
wedding events are a luxury, their income elasticity of demand is
greater than 1. - The supply schedule of longdistance phone calls is in the
table. Calculate the elasticity
of supply when
a. The price falls from 40¢ to 30¢ a
minute.
The elasticity of supply is 1.
The elasticity of supply is the
percentage change in the quantity
supplied divided by the
percentage change in the price. When the price falls from 40 cents
to 30 cents, the change in the price is 10 cents and the average
price is 35 cents. The percentage change in the price is 28.57
percent. When the price falls from 40 cents to 30 cents, the
quantity supplied decreases from 800 to 600 calls. The change in the
quantity supplied is 200 calls, and the average quantity is 700
calls, so the percentage change in the quantity supplied is 28.57
Price
(cents
per minute)
Quantity
supplied
(millions of
minutes per
day)
10 200
20 400
30 600
40 800
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8 2 C H A P T E R 4
percent. The elasticity of supply equals (28.57 percent)/(28.57
percent), which is 1.
b. The average price is 20¢ a minute.
The elasticity of supply is 1. The formula for the elasticity of
supply calculates the elasticity at the average price. So to find
the elasticity at an average price of 20 cents a minute, change the
price such that 20 cents is the average price—for example, a fall in
the price from 30 cents to 10 cents a minute. When the price falls
from 30 cents to 10 cents, the change in the price is 20 cents and
the average price is 20 cents. The percentage change in the price is
100 percent. When the price falls from 30 cents to 10 cents, the
quantity supplied decreases from 600 to 200 calls. The change in the
quantity supplied is 400 calls and the average quantity is 400
calls. The percentage change in the quantity supplied is 100
percent. The elasticity of supply is the percentage change in the
quantity supplied divided by the percentage change in the price. The
elasticity of supply is 1. - Weak Coal Prices Hit China’s Third-Largest Coal Miner
The chairman of Yanzhou Coal Mining reported that the recession
had decreased the demand for coal, with its sales falling by 11.9
per cent to 7.92 million tons from 8.99 million tons a year
earlier, despite a 10.6 percent cut in the price.
Source: Dow Jones, April 27, 2009
Calculate the price elasticity of supply of coal. Is the supply
of coal elastic or inelastic?
The price elasticity of supply of coal equals the percentage change
in the quantity of coal supplied divided by the percentage change in
the price of coal. Using the data in the problem, the price
elasticity of supply equals (−11.9 percent)/(−10.6 percent), which is
1.12. The elasticity exceeds 1.0 in value, so the supply of coal is
elastic.
Economics in the News - After you have studied Reading Between the Lines on pp. 98–99,
answer the following questions.
a. Which demand is more price elastic and why: tomatoes in general
or Florida winter tomatoes?
The price elasticity of demand for Florida winter tomatoes is more
price elastic than the demand for tomatoes in general. It is more
elastic because there are more substitutes for (the narrowly defined
good) Florida winter tomatoes than for (the broadly defined good)
tomatoes in general.
b. When cold weather destroyed the Florida crop and more tomatoes
came from Mexico and greenhouses, what happened to the supply of
tomatoes and the quantity of tomatoes supplied?
The supply of tomatoes decreased because of the freeze in Florida.
The quantity of tomatoes supplied increased because of the higher
price of tomatoes.
c. The news article says the “high demand has driven up prices” and
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E L A S T I C I T Y 8 3
“wholesalers are buying from Mexico.” What does this statement
mean? Did demand increase? Did it decrease? Is the news article
correct?
This statement means that the initial shortage of tomatoes, which
meant there was excess demand, drove the price higher. Contrary to
what the article implies, demand did not change; that is, the demand
curve did not shift. But the quantity demanded decreased in response
to the higher price.
d. Reggie Brown says “We’re obviously losing market share to
Mexico, and there’s always a price to pay to get the customer to
get back into the Florida market.” What does he mean and what
does that imply about the elasticity of demand for Florida
tomatoes when the price rises and when the price falls?
Mr. Brown is suggesting that the demand for Florida tomatoes is
inelastic. When the demand is inelastic, the increase in the
quantity of Florida tomatoes as growers recover from the cold
weather leads to a large fall in the price of tomatoes. With an
inelastic demand, the farmers’ total revenue decreases and this
decrease in total revenue is the “price to pay” to which Mr. Brown
refers.