Suppose that business travelers and vacationers have

Economics Homework

• The price elasticity of demand measures how much the quantity demanded responds to changes in the price. Demand tends to be more elastic if close substitutes are available, if the good is a luxury rather than a necessity, if the market is narrowly defined, or if buyers have substantial time to react to a price change.

• The price elasticity of demand is calculated as the percentage change in quantity demanded divided by the percentage change in price. If quantity demanded moves proportionately less than the price, then the elasticity is less than 1, and demand is said to be inelastic. If quantity demanded moves proportionately more than " the price, then the elasticity is greater than 1, and demand is said to be elastic.

• Total revenue, the total amount paid for a good, equals the price of the good times the quantity sold. For inelastic demand curves, total revenue moves in the same direction as the price. For elastic demand curves, total revenue moves in the opposite direction as the price.

• The income elasticity of demand measures how much the quantity demanded responds to

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CHAPTER 5 ELASTICITY AND ITS APPLICATION 107

changes in consumers' income. The cross-price elasticity of demand measures how much the quantity demanded of one good responds to changes in the price of another good.

The price elasticity of supply measures how much the quantity supplied responds to changes in the price. This elasticity often depends on the · time horizon under consideration. In most.mar- kets, supply is more elastic in ·the long run than in the short run.

The price elasticity of supply is calculated as the percentage change in quantity supplied divided by the percentage change in price. If quantity supplied moves proportionately less than the price, then the elasticity is less than 1, and sup- ply is said to be inelastic. If quantity supplied moves proportionately more than the price, then the elasticity is greater than 1, and supply is said to be elastic.

The tools of supply and demand can be applied in many different kinds of markets. This chap- ter uses them to analyze the market for wheat, the market for oil, and the market for illegal drugs.

elasticity, p. 90 price elasticity of demand, p. 90 total revenue, p. 94

income elasticity of demand, p. 97 cross-price elasticity of

price elasticity of supply, p. 98

demand, p. 97

Define the price elasticity of demand and the income elasticity of demand.

2. List and explain the four determinants of the price elasticity of demand discussed in the chapter.

3. What is the main advantage of using the midpoint method for calculating elasticity?

4. If the elasticity is greater than 1, is demand elastic or inelastic? If the elasticity equals 0, is demand· perfectly elastic or perfectly inelastic?

5. On a supply-and-demand diagram, show equilibrium price, equilibrium quantity, and the total revenue received by producers.

6. If demand is elastic, how will an increase in price change total revenue? Explain.

7. What do we call a good whose income elasticity is less than 0?

8. How is the price elasticity of supply calculated? Explain what it measures.

9. What is the price elasticity of supply of Picasso paintings?

108 PART II HOW MARKETS WORK

10. Is the price elasticity of supply usually larger in

the short run or in the long run? Why?

·plto1LEM~•··Af'4.o;:A~~i; 1. For each of the following pairs of goods, which

good would you expect to have more elastic demand and why? a. required textbooks or mystery novels b. Beethoven recordings or classical music

recordings in general c. subway rides during the next six months or

subway rides during the next five years d. root beer or water

2. Suppose that business travelers and vacationers have the following demand for airline tickets from New York to Boston:

Price

$150 200 250 300

Quantity Demanded (business travelers)

2, 1 00 tickets 2,000 1,900 1,800

Quantity Demanded (vacationers)

1,000 tickets 800 600 400

a. As the price of tickets rises from $200 to $250, what is the price elasticity of demand for (i) business travelers and (ii) vacation- ers? (Use the midpoint method in your calculations.)

b. Why might vacationers have a different elasticity from business travelers?

3. Suppose the price elasticity of demand for heating oil is 0.2 in the short run and 0.7 in the long run. a. if the price of heating oil rises from $1.80

to $2.20 per gallon, what happens to the quantity Qf heating oil demanded in the short run? In the long run?.(Use the midpoint method in your calculations.)

b. Why might this elasticity depend on the time horizon?

4. A price change causes the quantity demanded of a good to decrease by 30 percent, while the total revenue of that good increases by 15 percent. Is the demand curve elastic or inelastic? Explain.

,.

11. How can elasticity help explain why drug interdiction could reduce the supply of drugs, yet possibly increase drug-related crime?

5. The equilibrium price of coffee mugs rose sharply last month, but the equilibrium quantity was the same as ever. Three people tried to explain the situation. Which explanations could be right? Explain your logic.

BILLY: Demand increased, but supply was totally inelastic.

MARIAN: Supply increased, but so did demand.

\( ALERIE: Supply decreased, but demand was · totally inelastic.

6. Suppose that your demand schedule for DVDs is as follows:

Price

$ 8 10 12 14 16

Quantity Demanded (income= $10,000)

40 DVDs 32 24 16 8

Quantity Demanded (income= $12,000}

50 DVDs 45 30 20 12

a. Use the midpoint method to calculate your price elasticity of demand as the price of DVDs increases from $8 to $10 if (i) your income is $10,000 and (ii) your income is $12,000.

b. Calculate your income elasticity of demand as your income increases from $10,000 to $12,000 if (i) the price is $12 and (ii) the price is $16.

7. You have the following information about good X and goodY: • Income elasticity of demand for good X: -3 • Cross-price elasticity of demand for good X

with respect to the price of goodY: 2 Would an increase in income and a decrease in the price of good Y unambiguously decrease the demand for good X? Why or why not?

8. Maria has decided always to spend one-third of her income on clothing.